**computation **

Unlike the NPV method, calculating the value of IRR is more difficult. The procedure will depend on whether the cash flows are annuity or mixed stream.

**Annuities** The following steps are taken in determining IRR for an annuity:

• Determine the pay back period of the proposed investment. .

• In Table A-4 (present value of an annuity) look for the pay back period that is equal to or closest to the life of the project.

• In the year row, find two P V values or discount factor (D Fr) closest to PB period but one bigger and ‘other smaller than it.

• From the top row of the table, note interest rate (,.) corresponding to these P V values (D Fr).

• Determine actual IRR by interpolation. This can he done either directly using Equation 10.11 or indirectly by finding present values of annuity (Equation l0.12.

where

PH = Pay back period

DF, = Discount factor for ‘interest rate r.

DF rt = Discount factor for lower interest rate

DF rH = Discount factor for higher interest rate.

r = Either of the two interest rates used in the formula

Alternatively,

where

PVco = Present value of cash outlay

PVCFAT = Present value of cash inflows (DF , x annuity)

r = Either of the two interest rates used in the formula

r= Difference in interest rates

MV = Difference in calculated present values of inflows

The computations are shown in Example 10.7.

A project costs Rs 36,000 and is expected to generate cash inflows of Rs 11,200 annually for S years. Calculate the IRR of the project.

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