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Figure 6-4:
Calculating
the return
on a
venture.
The IRR function has been used to calculate an expected rate of return. The
formula in cell B10 is =IRR(B3:B7). The entered range includes all the cash
flows, in and out.
This project has an internal rate of return of 11 percent. By the way, the
investment amount in this case is the sum of all the cash flows out — \$8,400.
Earning back \$11,960 makes this a good investment. The revenue is
significantly higher than the outlay.
Even though a business opportunity seems worthy after IRR has been applied,
you must consider other factors. For example, you may have to borrow the
money to invest in the business venture. The real number to look at is the IRR
of the business venture less the cost of borrowing the money to invest.
However, the project can now be compared to other investments. Another
project may calculate to a higher internal rate of return. Then the second
project would make sense to pursue. Of course, don’t forget the fun factor.
Making a CD may be worth giving up a few extra points!
When comparing opportunities using the IRR function, a higher returned value
is a better result than a lower IRR.
Figure 6-5 compares the business venture in Figure 6-4 with another
investment opportunity. The second business venture is to start up a video-taping
business for weddings and other affairs. There is a significant outlay for
equipment and marketing. An internal rate of return is calculated for the first year,
and then for the first and second year together. Cell H10 has the formula
=IRR(H3:H5), and cell H11 has the formula =IRR(H3:H6). It’s clear that
even within the first year the second business venture surpasses the first.
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