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The IRR can be defined as the discount rate which, when applied to the cash flows of a project, produces a net present value (NPV) of nil. This discount rate can then be thought of as the forecast return for the project. If the IRR is greater than a pre-set percentage target, the project is accepted.
There are four methods we can use to determine the MIRR, two using a spreadsheet package, and two manual methods – which are more relevant to the exam. This is a useful method to start with as it will allow you to familiarise yourself with the definition of MIRR.
The IRR is essentially the discount rate where the initial cash out (the investment) is equal to the PV of the cash in. So, it is the discount rate where the NPV = 0. It is actual return on the investment (%).
These notes are created by concentrating as much as possible on the F9 study guide found on the ACCA website, following the requirements of the study guide and covering almost everything what you need to know to pass this exam.
The general formula for the estimation of the IRR of a capital investment project by interpolation or extrapolation is: Approximate IRR = lower discount rate ±* [change in discount rate (%) between the two points x (NPV at lower discount rate ÷ change in NPV between the two points)] * This will be + if the lower discount rate has a positive NPV.
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If you draw a graph of the NPV against the rate of interest, then usually it is a downward sloping curve and there is just one IRR. However, you can have the situation when the curve goes upwards, then turns and goes downwards and crosses the axis twice – i.e. 2 internal returns.
