Internal rate of return

When you make a capital investment, whether in equipment for your existing business or by investing in another business, you do so because you expect to generate income in the future. If this were not the case, you would not make the investment. If capital investments are relatively small, it is unlikely that you will need special techniques to appraise them.

The simplest, and least useful method, is to compare total revenue with total expenditure.

An investment appraisal compares cash outflows now with the likely cash inflows at some time in the future. Since the ‘worth’ of money changes over time, this presents a challenge if the capital asset – or the investee business – has an expected life of many years. The most effective techniques can be used to assess investments from the small – such as deciding whether it is cheaper to lease equipment than to buy it – to the large – such as deciding whether to build a new factory or invest in a business in a new market.