Rate of Return
Home Up Equivalence Project Cash Flows Rate of Return Typos in Text

 

Return on investment under inflation: Just as we had an inflation-free interest rate, so do we have an inflation-free internal rate of return, or IRR'.    IRR' is the rate of return on the constant dollar after-tax benefits.   Because of the inflation tax described earlier, for projects with depreciable assets, IRR' will be lower than IRR, the rate of return for actual dollar after-tax cash flows.  Example 13.12 illustrates this effect.

IRR' can also be computed from IRR, if the value of the general inflation rate is known.  This computation is similar to the one used to compute i' from i and the general inflation rate.  The "comments" in Example 13.12 show how this is done.

Typo: The last row in Table 13.5 (page 610) should read "(in constant dollars)" and not "(in actual dollars)".

Working capital under inflation:  Projects that need working capital can also be adversely affected by inflation.  Working capital needs will increase due to inflation and the project's rate of return will decrease because of this need for additional outflows of cash.  In Example 13.13 the rate of return drops from 29.89 to 18.09% due to the effect of the working capital drain.  Figure 13.6 is a pictorial depiction of this effect.