Internal Rate of Return (IRR)

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Internal Rate of Return (IRR)

The IRR method is more complex but has the advantage that it compares projects of different sizes. The IRR is the disount rate that equates to present value of the expected future cash flows to the initial cost of the project (i.e. the purchase of a new instrument). The image on the right shows the equation and an example calculation.
The main advantage of IRR is that it expresses the return on investment in percent, fostering easy comparison of projects of different sizes. For example, institution management might use it to decide whether to invest in a new instrument for the laboratory or for a new X-Ray machine with their limited capital equipment budget for the year. If one has a significantly higher IRR that will likely influence their decision if all other factors are equal. fortunately, there are computer generated calculators that can be found online that can be used to determine IRR. An example site is https://www.thecalculatorsite.com/finance/calculators/irr-calculator.php.
NPV may be the best financial indicator to use in a capital equipment project for a number of reasons. One reason is that the internal rate of return (IRR) calculates a rate of return which is offered by the project irrespective of the required rate of return and any other thing. Another disadvantage is that IRR does not understand economies of scale and ignores the dollar value of the project. It cannot differentiate between two projects with the same IRR but vast difference between dollar returns. On the other hand, NPV talks in absolute terms and therefore this point is not missed.
Image on the right is figure 25 from: Bruce AW. Financial Management of the Physician OIffice Laboratory. 747 Third Avenue, New York, N.Y 10017: Thompson Publishing Group, Inc.; 1995.