“You miss 100 percent of the shots you never take, and if you think it’s expensive to hire a professional to do the job, wait until you hire an amateur “
The internal rate of return (IRR) is the core component of capital budgeting and corporate finance. Businesses use it to determine which discount rate makes the present value of future after-tax cash flows equal the initial cost of the capital investment. Or, to put it more simply: What discount rate would cause the net present value (NPV) of a project to be $0? We expect that projects to grow our business will give us some return over time, so what is the lowest level of return we can tolerate? The lowest level is always the cost of capital to fund the project.
If a project is expected to have an IRR greater than the rate used to discount the cash flows, then the project adds value, while if the IRR is less than the discount rate, it destroys value. This decision process to accept or reject a project is known as the IRR Rule.
One advantage of using IRR, which is expressed as a percentage, is that it normalizes returns – everyone understand what a 25% rate means, compared to the hypothetical dollar equivalent (the way the NPV is expressed). Unfortunately, there are also several critical disadvantages with using the IRR to value projects.
In the first place, you should always pick the project with the highest NPV, not necessarily the highest IRR – because, at the end of the day, your financial statements are measured in dollars, not percents. If faced with two projects, Project A with 25% IRR and Project B with 50% IRR, but Project A has a higher NPV, you would pick Project A. The second big issue is that mathematically, the IRR assumes you can always continue to reinvest any incremental cash flow at the same IRR, which is infrequently the case. A more conservative approach is the Modified IRR (MIRR), which assumes reinvestment at the discount rate.
The IRR Formula
The IRR cannot be derived easily. The only way to calculate it by hand is through trial and error, because you are trying to arrive at whatever rate which makes the NPV equal to zero. For this reason, we’ll start with calculating NPV:
NPV= ∑ {After-Tax Cash Flow / (1+r)^t} – Initial Investment
Broken down, each period’s after-tax cash flow at time t is is discounted by some rate, r. The sum of all these discounted cash flows is then offset by the initial investment, which equals the current NPV. To find the IRR, you would need to “reverse engineer” what r is required so that the NPV equaled zero.
Financial calculators and software like Microsoft Excel contain specific functions for calculating IRR, but any calculation is only as good as the data driving it. To determine the IRR of a given project, you need to first reasonably estimate the initial outlay (the cost of capital investment), and then all the subsequent future cash flows. In almost every case, arriving at this input data is more complex than the actual calculation performed.
Calculating IRR in Excel
There are two ways to calculate IRR in Excel:
- using one of the three built-in IRR formulas
- breaking out the component cash flows and calculating each step individually, then using those calculations as inputs to an IRR formula. As we detailed above, since the IRR is a derivation there is no easy way to break it out by hand.
The second method is preferable because financial modeling best practices require calculations to be transparent and easy to audit. The trouble with piling all of the calculations into a formula is that you can’t easily see what numbers go where, or what numbers are user inputs or hard-coded.
Here is a simple example. What makes it simple, among other things, is that the timing of cash flows is both known and consistent (one year apart).
Assume a company is assessing the profitability of Project X. Project X requires $250,000 in funding and is expected to generate $100,000 in after-tax cash flows the first year, and then grow by $50,000 for each of the next four years.
You can break out a schedule as follows (if table is hard to read, right-click and hit “view image”
The initial investment is always negative, because it represents an outflow. You are spending something now, and anticipating results later. Each subsequent cash flow could be positive or negative; it depends entirely on the estimates of what the project delivers in the future.
In this case, we get an IRR of 56.77%. Given our assumption of a weighted average cost of capital (WACC) of 10%, the project adds value.
Keep in mind the limitations of IRR: It will not show the actual dollar value of the project, which is why we broke out the NPV calculation separately. Also, recall that the IRR assumes we can constantly reinvest and receive a return of 56.77%, which is unlikely. For this reason, we assumed incremental returns at the risk-free rate of 2%, giving us an MIRR of 33%.
The Bottom Line
The IRR helps managers determine which potential projects add value and are worth undertaking. The advantage from expressing project value as a rate is the clear hurdle it provides – as long as the financing cost is less than the rate of potential return, the project adds value.
The disadvantage to this tool is that the IRR is only as accurate as the assumptions that drive it, and that a higher rate does not necessarily mean the highest value-add project. Multiple projects can have the same IRR but dramatically different return profiles due to the timing and size of cash flows, the amount of leverage used, or differences in return assumptions. Another factor to keep in mind: IRR’s assumption of a constant reinvestment rate, which may well be higher than a conservative risk-free rate.
Read more: What is the formula for calculating internal rate of return (IRR) in Excel? | Investopedia http://www.investopedia.com/ask/answers/022615/what-formula-calculating-internal-rate-return-irr-excel.asp#ixzz4pvry7DoD
ARE YOU READY TO SELL OR PURCHASE YOUR LAND OR COMMERCIAL BUILDING IN PHOENIX, SCOTTSDALE, MARICOPA COUNTY AND PINAL COUNTY, ARIZONA, CLICK HERE AND PLEASE CALL ME.
FROM ME:
Phoenix Commercial Real Estate and Investment Real Estate: Investors and Owner / Users need to really know the market today before making a move in owner user Commercial Properties, Investment Properties and land in Phoenix / Maricopa County, Pinal County / Arizona, as the market has a lot of moving parts today. What is going on socio-economically, what is going on demographically, what is going on with location, with competing businesses, with public policy in general — all of these things affect the quality of selling or purchasing your Commercial Properties, Commercial Investment Properties and Commercial and large tracts of Residential Land Therefore, you need a broker, a CCIM (Certified Commercial Investment Member) who is a recognized expert in the commercial and investment real estate industry and who understands Commercial Properties and Investment Properties. I am marketing my listings on Costar, Loop-net CCIM, Kasten Long Commercial Group. I also sold hundreds millions of dollars’ worth of Investment Properties / Owner User Properties in Retail, Office Industrial, Multi-family and Land in Arizona and therefore I am working with brokers, Investors and Developers. I am also a CCIM and through this origination ( www.ccim.com ) I have access to marketing not only in the United States, but also internationalClick here to find out what is a CCIM: https://en.wikipedia.org/wiki/CCIM
Timeline of Arizona from 900 BC – 2017
Please call or text me on my cell: 520-975-5207 or send me an e-mail walterunger@ccim.net
WHY PHOENIX? AMAZING!!! POPULATION IN 1950 – 350 K PEOPLE; “NOW 5 MIL”. – “5TH. BIGGEST CITY IN USA”
ARIZONA FACTS – YEAR 1848 TO 2013
Timeline of Arizona from 900 BC – 2017
DOT – LOOP 202 / SOUTH MOUNTAIN FREEWAY / PHOENIX AZ – UNDER CONSTRUCTION
- DEMOGRAPHIC FACTS ABOUT MARICOPA COUNTY:
- The average age of the population is 34 years old.
- The health cost index score in this area is 102.1. (100 = national average)
- Here are some of the distributions of commute times for the area: <15 min (22.7%), 15-29 min (36.8%), 30-44 min (25.1%), 45-59 min (8.6%), >60 min (6.8%).
PHOENIX PROJECTED AS NUMBER ONE US HOUSING MARKET FOR 2017
LIST OF ECONOMIC DEVELOPMENT PROJECTS IN PINAL COUNTY, REVISED 2-14-17
Reasons to Consider me for Commercial Referrals – I have the Knowledge and Experience
Click here to View My Listings and Profile
Click here to find out what is a CCIM:
Click here to view my website:
Click her to join my mailing list :
Walter Unger CCIM – walterunger@ccim.net – 1-520-975-5207 – http://walter-unger.com
2016 Official Arizona Visitors Guide
Timeline of Phoenix, Arizona history
Facts of Arizona – year 1848 to 2013
Feel free to contact Walter regarding any of these stories, the current market, distressed commercial real estate opportunities and needs, your property or your Investment Needs for Commercial Properties
Tucson, Arizona.
1-520-975-5207
Check out my professional profile and connect with me on LinkedIn.
Kasten Long Commercial Group tracks all advertised apartment communities, including those advertised by other brokerages. The interactive map shows the location of each community (10+ units) and each location is color coded by the size (number of total units).
Walter Unger CCIM, CCSS, CCLS
I am a successful Commercial / Investment Real Estate Broker in Arizona now for 20 years. If you have any questions about Commercial / Investment Properties in Phoenix or Commercial / Investment Properties in Arizona, I will gladly sit down with you and share my expertise and my professional opinion with you. I am also in this to make money therefore it will be a win-win situation for all of us.
Please reply by e-mail walterunger@ccim.net or call me on my cell 520-975-5207
Walter Unger CCIM
Senior Associate Broker
Kasten Long Commercial Group
5110 N 40th Street, Suite 110
Phoenix , AZ 85018
Direct: 520-975-5207
Fax: 602-865-7461
Reasons to Consider me for Commercial Referrals
Delivering the New Standard of Excellence in Commercial Real Estate
- Commercial Real Estate Scottsdale
- Commercial Real Estate Phoenix
- Commercial Real Estate Arizona
- Commercial Investment Properties Phoenix
- Commercial Investment Properties Scottsdale
- Commercial Investment Properties Arizona
- Land Specialist Arizona
- Arizona Land Specialist
- Land Specialist Phoenix
- Phoenix Land Specialist
- Land For Sale Phoenix
- Land for sale Arizona
- Commercial Properties For Sale Phoenix
- Commercial Real Estate Sales Phoenix
- Commercial Properties Phoenix
- Commercial Properties Arizona
- Commercial Land Specialist Phoenix
- Commercial Land Phoenix
- Multifamily land Phoenix
- Retail Land Phoenix
- Industrial Land Phoenix
- Land Commercial Phoenix
- Land Retail Phoenix
- Land Industrial Phoenix
- Land Multifamily Phoenix
- Industrial Land for sale Phoenix
- Land Industrial
- P
- Investment Real Estate
Disclaimer of Liability
The information in this blog-newsletter is for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice, or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal, or other competent advisers. Before making any decision or taking any action, you should consult a professional adviser who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this e-newsletter are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy, or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability, and fitness for a particular purpose.