For a Mixed Stream or Cash Flows
Calculating the IRR for a mixed stream of cash flows is more tedious. In a mixed stream of Cash flows, the inflows in various years are uneven or unequal. One way to simplify the process is to use fake annuity’ as a starting point.P The following procedure is a useful guide to calculating IRR:
1. Calculate the average annual cash inflow 10 get a fake annuity
2. Determine fake pay hack period’ dividing the initial Tactility by the average annual CFAT determined In step 1.
3. Look for the factor. in Table A-4, closer to the fake pay back value in the same manner as in the case of annuity. The result will he a rough approximation of the IRR, based on the assumption that the mixed ,tr I 111 is an annuity (fake annuity).
4_ Adjust subjectively the IRR obtained in step 3 by comparing the pattern of average annual cash inflow, (as per stet, II to till’ actual mixed stream of cash flows. If the actual cash flows stream happen, to he higher in the initial years of the project’s lift’ than the average stream, adjust the IRK a few percentage points upward Till reason is obvious a the greater recovery of funds in the earlier rely, is likely to give a higher yield rate ORRl. Conversely, if in the early years the actual cash inflows arc below the average, adjust the IRR a few percentage points downward, If the average cash flows pattern seems fairly close to the actual pattern, no adjustment is to be: made.
5. Find out the present value (using Table A-3J of the mixed cash flows, taking the IRR as the
discount rate as estimated in step 4.
6. Calculate the PV, using the discount rate. If the PV of CFAT equals the initial outlay, that is NPV is zero, it is the IRR. Otherwise, repeat step S. Stop, once two consecutive discount rates that cause the PV to 1)(:: positive and negative, respectively have been calculated. whichever of these two rates causes the J’liPV to be closest to zero is the IRR to the nearest 1 per cent.
7. The’ actual value can be ascertained by the method of interpolation as in the case of an annuity.
let us apply this procedure for determining the IRR of Example 10.6 of a mixed stream of CFAT for machines A and B. The -cash flows associated uh the machines are given in Table 10.7.