Financial Terms IRR

# Definition of IRR

## IRR

See internal rate of return.

# Related Terms:

## Basic IRR rule

Accept the project if irr is greater than the discount rate; reject the project is lower than the
discount rate.

## Irrational call option

The implied call imbedded in the MBS. Identified as irrational because the call is
sometimes not exercised when it is in the money (interest rates are below the threshold to refinance).
Sometimes exercised when not in the money (home sold without regard to the relative level of interest rates).

## Irrelevance result

The Modigliani and Miller theorem that a firm's capital structure is irrelevant to the firm's
value.

## Internal rate of return (IRR)

A discounted cash flow technique used for investment appraisal that calculates the effective cost of capital that produces a net present value of zero from a series of future cash flows and an
initial capital investment.

## internal rate of return (IRR)

The precise discount rate that makes the
present value (PV) of the future cash returns from a capital investment
exactly equal to the initial amount of capital invested. If irr is higher
than the company’s cost-of-capital rate, the investment is an attractive
opportunity; if less, the investment is substandard from the cost-ofcapital
point of view.

## Internal Rate of Return (IRR)

The discount rate that equates the present value of the net cash
inflows with the present value of the net cash outflows
(investments). The irr measures the profitability (rate of return) of
an investment in a project or security.

## internal rate of return (IRR)

the expected or actual rate of
return from a project based on, respectively, the assumed
or actual cash flows; the discount rate at which the net
present value of the cash flows equals zero

## internal rate of return (IRR)

Discount rate at which project NPV = 0.

## MM dividend-irrelevance proposition

Theory that under ideal conditions, the value of the firm is unaffected by dividend policy.

## MM's proposition I (debt irrelevance proposition)

The value of a firm is unaffected by its capital structure.

## Accounting Irregularities

Intentional misstatements or omissions of amounts or disclosures in
financial statements done to deceive financial statement users. The term is used interchangeably with fraudulent financial reporting.

## Irrevocable Beneficiary

Legal designation that cannot be contested. (See beneficiary)

## Incremental internal rate of return

irr on the incremental investment from choosing a large project

## Legal defeasance

The deposit of cash and permitted securities, as specified in the bond indenture, into an
irrevocable trust sufficient to enable the issuer to discharge fully its obligations under the bond indenture.

## Modigliani and Miller Proposition I

A proposition by Modigliani and Miller which states that a firm cannot
change the total value of its outstanding securities by changing its capital structure proportions. Also called
the irrelevance proposition.

## Multiple rates of return

More than one rate of return from the same project that make the net present value
of the project equal to zero. This situation arises when the irr method is used for a project in which negative
cash flows follow positive cash flows. For each sign change in the cash flows, there is a rate of return.

## Perfect market view (of capital structure)

Analysis of a firm's capital structure decision, which shows the
irrelevance of capital structure in a perfect capital market.

## Perfect market view (of dividend policy)

Analysis of a decision on dividend policy, in a perfect capital
market environment, that shows the irrelevance of dividend policy in a perfect capital market.

## Reclamation

A claim for the right to return or the right to demand the return of a security that has been
previously accepted as a result of bad delivery or other irregularities in the delivery and settlement process.

## Underinvestment problem

The mirror image of the asset substitution problem, wherein stockholders refuse
to invest in low-risk assets to avoid shifting wealth from themselves to the debtholders.
Underlying
The "something" that the parties agree to exchange in a derivative contract.

## Cost pool

The costs of (cross-functional) business processes, irrespective of the organizational structure of the business.

## extraordinary gains and losses

No pun intended, but these types of gains
and losses are extraordinarily important to understand. These are nonrecurring,
onetime, unusual, nonoperating gains or losses that are
recorded by a business during the period. The amount of each of these
gains or losses, net of the income tax effect, is reported separately in the
income statement. Net income is reported before and after these gains
and losses. These gains and losses should not be recorded very often, but
in fact many businesses record them every other year or so, causing
much consternation to investors. In addition to evaluating the regular
stream of sales and expenses that produce operating profit, investors
also have to factor into their profit performance analysis the perturbations
of these irregular gains and losses reported by a business.

## sunk cost

A cost that has been paid and cannot be undone or reversed.
Once the cost has been paid, it is irretrievable, like water over the dam
or spilled milk. Usually, the term refers to the recorded value of an asset
that has lost its value in the operating activities of a business. Examples
are the costs of products in inventory that cannot be sold and fixed
assets that are no longer usable. The book value of these assets should
be written off to expense. These costs should be disregarded in making
decisions about what to do with the assets (except that the income tax
effects of disposing of the assets should be taken into account).

## reinvestment assumption

an assumption made about the rates of return that will be earned by intermediate cash flows from a capital project; NPV and PI assume reinvestment at the discount rate; irr assumes reinvestment at the irr

## Accrual accounting

The recording of revenue when earned and expenses when
incurred, irrespective of the dates on which the associated cash flows occur.

## Fixed cost

A cost that does not vary in the short run, irrespective of changes in any
cost drivers. For example, the rent on a building will not change until the lease
runs out or is re-negotiated, irrespective of the level of business activity within
that building.

That portion of total overhead costs which remains constant in size
irrespective of changes in activity within a certain range.

## Fraudulent Financial Reporting

Intentional misstatements or omissions of amounts or disclosures
in financial statements done to deceive financial statement users. The term is used interchangeably
with accounting irregularities. A technical difference exists in that with fraud, it
must be shown that a reader of financial statements that contain intentional and material misstatements
must have used those financial statements to his or her detriment. In this book, accounting
practices are not alleged to be fraudulent until done so by an administrative, civil, or
criminal proceeding, such as that of the Securities and Exchange Commission, or a court.

## First-in, first-out (FIFO)

An inventory valuation method under which one assumes that the
first inventory item to be stored in a bin is the first one to be used, irrespective of
actual usage.

## Last-in, first-out (LIFO)

An inventory valuation method under which one assumes that the
last inventory item to be stored in a bin is the first one to be used, irrespective of
actual usage.

## Beneficiary

This is the person who benefits from the terms of a trust, a will, an RRSP, a RRIF, a LIF, an annuity or a life insurance policy. In relation to RRSP's, RRIF's, LIF's, Annuities and of course life insurance, if the beneficiary is a spouse, parent, offspring or grand-child, they are considered to be a preferred beneficiary. If the insured has named a preferred beneficiary, the death benefit is invariably protected from creditors. There have been some court challenges of this right of protection but so far they have been unsuccessful. See "Creditor Protection" below. A beneficiary under the age of 18 must be represented by an individual guardian over the age of 18 or a public official who represents minors generally. A policy owner may, in the designation of a beneficiary, appoint someone to act as trustee for a minor. Death benefits are not subject to income taxes. If you make your beneficiary your estate, the death benefit will be included in your assets for probate. Probate filing fees are currently \$14 per thousand of estate value in British Columbia and \$15 per thousand of estate value in Ontario.
Another way to avoid probate fees or creditor claims against life insurance proceeds is for the insured person to designate and register with his/her insurance company's head office an irrevocable beneficiary. By making such a designation, the insured gives up the right to make any changes to his/her policy without the consent of the irrevocable beneficiary. Because of the seriousness of the implications, an irrevocable designation should only be made for good reason and where the insured fully understands the consequences.
NoteA successful challenge of the rules relating to beneficiaries was concluded in an Ontario court in 1996. The Insurance Act says its provisions relating to beneficiaries are made "notwithstanding the Succession Law Reform Act." There are two relevent provisions of the Succession Law Reform Act. One section of the act gives a judge the power to make any order concerning an estate if the deceased person has failed to provide for a dependant. Another section says money from a life insurance policy can be considered part of the estate if an order is made to support a dependant. In the case in question, the deceased had attempted to deceive his lawful dependents by making his common-law-spouse the beneficiary of an insurance policy which by court order was supposed to name his ex-spouse and children as beneficiaries.

## Preferred Beneficiary

Used in older contracts to confer the same rights as an irrevocable beneficiary. Applied to family members.