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Chapter 2

Internal rate of return (IRR) and

modified internal rate of return (MIRR)

3.1 Introduction to IRR

The IRR is the discount rate at which the project has a zero NPV.

Therefore IRR is particularly useful when trying to assess the sensitivity of the NPV
to changes in the cost of capital.

3.2 The IRR method and decision rule

 IRR can be estimated by linear interpolation:

Calculate two NPVs for the project at two different costs of capital
(L and H). Then:

N L
IRR = L + × (H – L)
N – N H
L
Where L = Lower rate of interest

H = Higher rate of interest

N L = NPV at the lower rate of interest

N H = NPV at higher rate of interest

 an IRR higher than the cost of capital normally means that the
project is financially acceptable.

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