What is Internal Rate of Return?

Definition of Internal Rate of Return

Internal Rate of Return is a way of determining the value of a project. It is simply the discount rate that makes the Future Value of a series of cash flows equal to the Present Value. If you remember the piece I wrote about Net Present Value, we are looking for the discount rate the makes Net Present Value equal to zero. See here for a definition of Present Value, Future Value, and discount rates.

Calculation Example

Let’s say a project lasts for 3 years. To initiate the project, you have to pay $20,000. Each year after that the project earns $10,000. The required rate of return (the minimum return you need to do a project) is 15%, should you do this project? The equation would be 0 = -20,000 + (10,000 / discount rate) + (10,000 / (discount rate squared)) + (10,000 / (discount rate cubed)). When you solve this equation with a financial calculator, excel or some other piece of software, the discount rate equals 23%. 23% is larger than 15%, therefore you should do the project.

Investment Fee Structure

Rate Assets Under Management
1.44% Below $125,000
1.00% Between $125,000 and $750,000
.85% Between $750,000 and $1,250,000
.80% Between $1,250,000 and $1,750,000
.75% Between $1,750,000 and $2,500,000
.70% Between $2,500,000 and $3,250,000
.65% Between $3,250,000 and $4,250,000
.60% Above $4,250,000

A single rate is applied to the entire account. So a person with a $750,000.01 account pays less than a person with a $750,000 account. I will waive personal tax return fees for accounts over $1 million. For accounts that are above $5,250,000, we’ll need to discuss a custom rate. 

As I’m writing these to help my readers, I would be very appreciative of any input in regards to what I should write next. If you want me to write about a particular topic, please contact me. Please contact me if you would like to submit a post to my blog.

If anything that I mentioned above interests you, please consider downloading my free e-book. The book contains my thoughts on investment management and some information that I think everyone should know. You can also download it below.

E-Book Download

Questions for the comments

Did my explanation make sense? Do you agree or disagree with what I said?

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