![]() You can also think of NPV as measuring the time value of money if you really want to geek out. It dictates what you should invest if you have a target end balance and return in mind. ![]() Simple enough.Īs for “net present value,” that refers to the value of all future cash flows for an investment, based on a specific discount rate or return. “Discount rate” refers to the rate of return you expect to receive. Let’s break that down into plain English. The technical definition of internal rate of return is “The discount rate that makes the net present value (NPV) of an investment project equal zero, in a cash flow analysis.” That’s how IRR works - it offers an “apples to apples” comparison between potential investments that pay returns on different timetables. That would leave you with a total net return of $40. If you’d invested $100 at 18.32%, you’d have received back $18.32 after the first year, and if you’d reinvested it at that same 18.32%, at the end of the second year, you’d receive back $21.68. Internal rate of return takes compounding returns into account. But that simple average doesn’t take compounding into account: if you had received returns in the first year, and had been able to reinvest those returns, you’d have earned even more returns on your returns. The average annual return would be 20%: $40 net return divided by two years. Imagine you invest $100 and you expect to receive it back plus a $40 profit at the end of two years. In plain English, internal rate of return is the compound interest rate you can expect to earn on an investment.
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