What is Internal rate of return or IRR
What is the meaning of internal rate of return (IRR) or economic rate of return or implicit rate of return ? How it is calculated ? How it is used in a real scenario ? Please explain with an example? And how it is used in consumer credit, i.e financing consumer for purchase of goods?
What is the meaning of internal rate of return (IRR) or economic rate of return or implicit rate of return ?
Internal Rate of Return is the rate used to measure the Returns that is given by company if invested in company's Business.
In simple terms it does not include any external factor affecting the prfitability. It only consider the internal resources using which company can earn.
How it is calculated ?
The rate is arrived by calculating the NPV of an investment. It is a rate to arrive at the initial investment required to achieve a target profit. For example: If by investing 100, company is earning 10 at year end than IRR is 10/100=10%.
How it is used in a real scenario ? Please explain with an example?
In real scenario before taking any investing step we should consider the IRR. IRR is the minimum profit rate or Discounting Factor that you should consider before accepting an investment.
Example: Suppose current IRR of your company is 10%, you should accept the proposals with IRR greater than 10%.
And how it is used in consumer credit, i.e financing consumer for purchase of goods?
It is very useful in deciding the Rate or cost of financing. Company consider the IRR to decide the finance cost.
Example: Suppose you are running a financing company. You have 1 crore and you can finance the consumers product with this money. How much will charge them for the financing help you provided?
Well you can not calculate the maximum rate to charge but minimum can be calculated by calculating the IRR on your 1 crore. Supppose Bank is Giving 9% interest on Term Deposit. Than your IRR is 9% and you will charge to customer higher than 9%.