"IRR" Formula question

[Grunter70]

Hi all,

When using the IRR formula, do the cash flows need to be manually discounted, or does the IRR formula do that for you?

Also, the IRR result doesn't seem to change when you amend the "Guess" parameter bit that is meant to refer to the Cost of Capital. Anyone know why this is?

Concerned the formula isn't working as it's meant to.

Thanks for any help.

 

[anandvarma]

You do not have to do manually discount any thing
All IRR needs is Cash flow should have at least one negative flow

Guess is optional, you can give value or leave it

 

[Grunter70]

Thanks for your answer.

I'm still not convinced though. - The fact the "Guess" (re. Cost of capital) doesn't impact the end result appears to suggest it's not getting used. Hence, the formula isn't discounting the future cashflows.

Does anyone out there use this formula for Capital investment Project appraisal work?

 

[anandvarma]

can you put up sample of data

 

[Grunter70]

No worries thanks Anandvarma - Going to go with what i've got for now. - Thanks for your time.

 

[Steve=True]

I have never used the guess. I am sure it is working correctly as long as you have put in the cash flows on a per period basis.

Also, from Microsoft, guess is a number that you guess is close to the result of IRR; 0.1 (10 percent) if omitted. I assume that it is only using this to start the permutations until it gets to the right answer as it is probably doing a goal seek operation using guess as a starting point.

Check out these posts about modeling:

http://chandoo.org/wp/2010/07/21/financial-modeling-introduction/

 

[brettdj]

Thanks for your answer.

I'm still not convinced though. - The fact the "Guess" (re. Cost of capital) doesn't impact the end result appears to suggest it's not getting used. Hence, the formula isn't discounting the future cashflows.

Does anyone out there use this formula for Capital investment Project appraisal work?

Guess can change the IRR answer when there are two or more solutions. It makes no difference to a single formula solution

And on pedantics, IRR does not return the cost of capital, it returns a theorectical breakeven discount rate

Lastly the answer is no. NPV is the correct metric to use for investments, capital budgeting etc. IRR is very much a secondary "headroom" check, it should never be used to make a decision

Cheers

Dave

 

[Trebor76]

it returns a theorectical breakeven discount rate

As I understand it (which, I realise is flawed from the beginning) the IRR actually returns the discount rate which equates the NPV to zero. It is the minimum breakeven rate for the project to return the same position as when you started - no better or worse off.

The guess helps Excel calculate (it will return #NUM! if it can't find it within 20 guesses) the IRR if you know (suspect) it's not near the default of 10 percent.