Archive for the ‘Financial Functions’ Category
This week, in the final article of this series, guest blogger Nick Williams discusses calculating the Internal Rate of Return for an irregular cashflow. Nick is an Access tutor based in the U.K.
XIRR – Internal Rate Of Return
XIRR function returns the value for an Internal Rate Of Return for a supplied series of cash flows, set of values. The key difference between IRR and XIRR is that XIRR can deal with cashflows that aren’t evenly spaced. Because it can deal with cashflows that aren’t evenly spaced you need to tell is both the series of cashflows and also the dates of each cashflow.
The syntax of the XIRR function in Excel is XIRR (values, dates, [guess])
values is a required parameter. It is an array or reference to a set of cells that contain the cash flow values.
dates is another required parameter, it is a series of dates. You need to have a date that corresponds to each cash flow for the calculation to run. The first date is the date of the investment/loan, and subsequent dates refer to income values.
guess is an optional parameter, and works as it does for IRR. Again, if this parameter is omitted, it is set to 0.1 (10%) by default
Continuing with our previous example, let’s introduce dates into our cash flow set.
We now have dates for the initial investment, and irregular dates of actual and/or forecasted income over the seven years of the project.
As we would expect, as the returns come sooner on this project the return on it has gone up, when compared with our previous calculation.
If we entered dates that were exactly one year apart for each of the cashflows this would give an answer of 1.82%, the same answer as using the IRR function.
Again continuing with our previous example, lets we add more expected income and periods. Again as the returns come sooner the return on the project has increased when compared to have all of the cashflows spaced exactly one year apart.
WHAT TO DO IF YOUR CALCULATION RETURNS #num!
Microsoft Excel uses an iterative technique for calculating IRR AND XIRR starting from guess. If XIRR can’t find a result that works after 100 tries/iterations, the #NUM! error value is returned. If this happens, or if the result is not what you expected to see, try again with setting a different value for guess.
#NUM! error can also appear if:
1. there isn’t at least one positive and at least one negative value in the list of cashflows
2. any of the specified dates precede the first specified date
3. the specified dates and values arrays have different lengths
XIRR can also return a #VALUE! error if it cannot not recognize any of the specified dates as dates (e.g. you have the value of 20 among your dates array)
This week, guest blogger Nick Williams discusses calculating the Internal Rate of Return for a regular cashflow. Nick is an Access tutor based in the U.K.
IRR – Internal Rate Of Return
IRR returns an interest rate. It is the interest rate that would need to be applied to all of the cashflows in the calculation to give an NPV of zero for the project (see above). In short it tells you the return on the money invested in a project and is often used as an investment decision tool. It is designed to work with a set of regularly spaced cashflows only.
IRR is the same as interest rate of savings or loan, however there is it applied to a very straight forward situation.
The syntax of the IRR function in Excel is IRR(values, [guess])
values is a required parameter. It is an array or reference to a set of cells that contain the cash flow values for the project.
guess is an optional parameter. It is a number that you are guessing is close to the result of IRR. If this parameter is omitted, it is set to 0.1 (10%) by default.
Continuing with our example of above we can see the function in use below.
Intuitively we know that that is right. Above we discovered that the project had a negative NPV if we applied a 3% discount rate. Therefore we knew that the discount rate to get an NPV of zero had to be below 3%.
Again, as above, lets add two more years of income and see what happens to the result. We got a positive NPV using a 3% rate before so we know that the answer will be above 3% before we start.
Note: Microsoft Excel uses an iterative technique for calculating IRR starting from guess. If IRR can’t find a result that works after 20 tries/iterations, the #NUM! error value is returned. If this happens, or if the result is not what you expected to see, try again with setting a different value for guess.
We’d like to welcome back guest blogger Nick Williams. This week and for the next two weeks, Nick will be publishing a series of Excel financial calculation tutorials. Nick is an Access tutor based in the U.K.
One area where Excel is used extensively is in financial forecasting and modeling. It contains lots of financial formulas which can save hours of time.
As ever the trick is to give Excel the right data in the right way … and then let it do the work for you.
In this article we’re going to have a quick look at three of the basic formulas that Excel has in its kit bag IRR, XIRR and NPV.
NPV – Net Present Value
The NPV returns a value amount. You insert all of the forecast cashflows (both investment and return) relating to a project and also your cost of capital. NPV will then tell you if the project will return a ‘profit’. Profit in this context is that it returns more than your cost of capital for the period that your capital is invested. Put the other way round the value of all of the projects future cashflows, today, is greater than nought.
The basis of the calculation is that a pound now is worth more than a pound in future. Your cost of capital (or discount rate) is the difference in value between a pound now and a pound in a year’s time.
To make this clearer a very simple illustration would be:
Imagine you are investing $10 today. You think that it will return $12 in one year’s time. You like to make at least 10% return on your money when it is invested so your cost of capital is 10%.
The net present value of the $12 today is $10.9 (=£11/(1+10%)) so the $12 in one year is worth more than the $10 today, meaning that you should invest as the project will earn you more than the 10% return that you need.
Syntax of the NPV function in Excel is NPV( rate, value1, [value2], [value3], … )
rate is a required parameter and is the discount rate or cost of capital over a single period.
value1, value2,… are values of future income (positive value) and/or payments (negative value). Value 1 is a required parameter and subsequent values are optional. You will need to put a value, even if it is zero, in for each period of the project.
Below is a more complex example. We have a $200,000 investment which returns different amounts each year for seven years.
We put the initial investment in cell B3. Initially we have the forecasted seven years of income in cells B4:B12. The cost of capital or annual discount rate is in cell B2.
After 7 periods our NPV is going to be:
If we add income for two additional periods, NPV is going to change: