IRR or Internal rate of return is the discount rate that will equate future cash inflows to the initial cash outflow or the investment value. Let’s work with a case study.
Assuming a PE company invested £100m in a company which gave dividends of £5m a year for five years and was sold after for £200m
The IRR (r) is the discount rate which will equate £100m to all the cash inflows i.e. £5m a year for five years and £200m.
Year 0 Year 1 Year 2 Year 3 Year 4 Year 5
-£100 £5 £5 £5 £5 £205
(1+r)^1 (1+r)^2 (1+r)^3 (1+r)^4 (1+r)^5
The IRR in the above case is 19%
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