Part 1 The Basics

generates these subsequent cashflows. This is equivalent to saying that, using

5.6 percent, the net present value of 87, +25, 40, +60 and +60 is zero.
Calculating a NPV is relatively simple: calculate each present value separately and add them together. Calculating an IRR however requires a
repeated trial and error method and is therefore generally done using a
specially designed calculator.

Example 1.15
What is the IRR of the following cashflows?
Now:
After 1 year:
After 2 years:
After 3 years:

$164
+$45
+$83
+$75

Answer: 10.59% (If you do not have a calculator able to calculate this, try checking
the answer by working backwards: the NPV of all the future values, using the rate
of 10.59%, should come to + $164).
See below for an explanation of how to use the HP19 to solve this.

Key Point

The internal rate of return is the interest rate which discounts all the
known future cashflows to a given NPV.
This is equivalent to the interest rate which discounts all the cashflows
including any cashflow now to zero.

Annuity
An annuity is a regular stream of future cash receipts which can be purchased by an initial cash investment. The size of the future cash receipts is
determined by the yield which can be obtained on the investment. In other
words, the internal rate of return of the cashflows (initial outflow and subsequent inflows) is the yield.

Example 1.16
An investor puts 50,000 in a 20-year annuity, yielding 7.2%. The annuity returns
an equal cash amount at the end of each year, with no additional amount at maturity. What is the annual cash amount?
Answer: 4,793.26. (If you do not have a calculator able to calculate this, you can
check the answer by working backwards: the NPV at 7.2% of 4,793.26 each year
for 20 years is 50,000.)
See below for an explanation of how to use the HP19 to solve this.

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