FINANCIAL TOOL
Internal Rate of Return
Last week, we looked at how to estimate the Net Present Value of a business idea or project.
If you’ve input the estimated cash flows, you can take one more simple step to capture another useful number.
The internal rate of return.
If you need a financial calculator, you can use a free app such as BA Financial Calculator on Google Play or BA Financial Calculator for iPhone.
Once you’ve entered the cash flows from last week, press IRR and then CPT.
This number reveals your estimated return on investment.
Using last week’s example of investing $100,000 in a business earning $30,000, growing the profits and then reselling after ten years, the IRR is 37.75%.
We can compare that with, say, 8% that we might expect to make on average investing in stocks.
That tells us that, all else being equal, the business idea is the better option in terms of potential return.
Of course, the risk and time commitment are other factors that have to be weighed.
If IRR and NPV give conflicting answers to which business or project you should take on, it’s generally best to rely on the NPV primarily.
Estimating these values can have a powerful impact on your perspective and willingness to make a life-changing decision, even when the future is uncertain.