IRR

IRR How to calculate

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IRR How to calculate

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero. In other words, it is the expected compound annual rate of return that will be earned on a project or investment.

When calculating IRR, expected cash flows for a project or investment are given and the NPV equals zero. Put another way, the initial cash investment for the beginning period will be equal to the present value of the future cash flows of that investment. (Cost paid = present value of future cash flows, and hence, the net present value = 0).

Once the internal rate of return is determined, it is typically compared to a company’s hurdle rate or cost of capital. If the IRR is greater than or equal to the cost of capital, the company would accept the project as a good investment. (That is, of course, assuming this is the sole basis for the decision).

In reality, there are many other quantitative and qualitative factors that are considered in an investment decision). If the IRR is lower than the hurdle rate, then it would be rejected, if IRR is the only investment consideration.

Under IFRS 16 ‘Leases’, a similar calculation is used to calculate discount rates are used to determine the present value of the lease payments used to measure a lessee’s lease liability. Discount rates are also used to determine lease classification for a lessor and to measure a lessor’s net investment in a lease.

For lessees, the lease payments are required to be discounted using:

For lessors, the discount rate will always be the interest rate implicit in the lease.

The interest rate implicit in the lease is defined in IFRS 16 as ‘the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.’

The lessee’s incremental borrowing rate is defined in IFRS 16 as ‘the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment’.

The incremental borrowing rate is determined on the commencement date of the lease. As a result, it will incorporate the impact of significant economic events and other changes in circumstances arising between lease inception and commencement.

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Amortised cost and the effective interest method

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Amortised cost and the effective interest method

This narrative explores the factors that an entity needs to consider in calculating the amortised cost of a financial asset or financial liability and recognising interest revenue and expense based on the effective interest rate (EIR).

Calculating amortised cost

The amortised cost of a financial asset or financial liability is calculated in the same way as under IAS 39, although IFRS 9 introduces the concept of ‘gross carrying amount’ for financial assets. The gross carrying amount is the amortised cost grossed up for the impairment allowance. The elements of amortised cost are illustrated below.

Financial assets

Financial liabilities

Fair value at initial recognition

At recognition a loan receivable or payable is recognised at fair value measured as the present value of all future cash receipts discounted using the prevailing market rate(s) of interest for a similar instrument (currency, term, etc.) with a similar credit rating.

MINUS

Principal redemptions/repayments

ADD

Periodical interest income based on the effective interest method

Periodical interest expense based on the effective interest method

MINUS

Gross carrying amount

N/A

Loss allowance

= Amortised costs

= Amortised costs

(no adjustment for loss allowance)

Calculating the EIR

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Leveraged buyout IFRS 3 best reporting

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Leveraged buyout IFRS 3 best reporting – In corporate finance, a leveraged buyout (LBO) is a transaction where a company is acquired using debt as the main source of consideration. These transactions typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70 or 80 percent of the purchase price) and funds the balance with their own equity. Leveraged buyout IFRS 3 best reporting

1 The process and business reason

The use of leverage (debt) enhances expected returns to the private equity firm. By putting in as little of their own money as possible, PE firms can achieve a large return on equity (ROE) and internal rate of return … Read more

Discount rate – How 2 best account it

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Discount rate used in discounted cash flow models incorporates the time value of money (the risk-free rate) and a risk premium build from distinct components

What are related parties?

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What are related parties – Related parties are relationships in which one party has the ability to control or significantly influence the economic and operating decisions of another. Transactions with related parties are a common feature of business. Typically related party relationships include the following:

  • Enterprises controlled or controlling one another, such as subsidiaries and joint venturesWhat are related parties
  • Individuals having an interest in the enterprise that gives them significant influence over the enterprise, such as majority owners
  • Key management personnel responsible for planning, directing and controlling the activities of the reporting enterprise, including close members of families of these individuals

Parties are considered related when one of the parties has control over the other or is able to exert considerable influence… Read more

Historical cost measurement

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Historical cost measurement – The historical cost of an asset is the amount paid for it and the historical cost of a liability is the amount received in respect of it or the amount expected to be paid to satisfy it.USD

Historical cost accounting is interpreted to require that the amount at which an asset is stated in the accounts should not exceed the amount expected to be recovered from either its use or its sale (its recoverable amount). Historical cost as it is understood is therefore recoverable historical cost.

Recoverable amount is usually considered to be the higher of an asset’s realisable value and its value in use. The resulting recoverable historical cost tree for determining an asset’s recoverable … Read more

Calculating the value of an acquisition – How 2 complete it best

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Calculating the value of an acquisition – This is a detailed example of calculating the fair value of an acquisition, using a logical step by step approach and realistic assumptions and determinations based on transaction and market data. Identifying and valuing intangible asset(s) is a broad endeavor and requires careful consideration of; factors specific to each business, the transaction structure, identifying the primary income generating asset, determining the discount rates, estimating the useful lives for identified intangibles. Examples of such intangibles include customer contracts, trademarks, brands, etc.

 

The Deal Fortune, Inc. acquired M&P Company on January 1, 2017. Consideration was $30 million cash plus additional contingent consideration, as follows:

EBITDA

  • Below 1 million: Nil Calculating the value of
… Read more

Customer relationships valuation

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Introduction

Customer relationships valuation is based on valuation model. Here such a valuation model is presented to value customer contracts and the related customer relationship and the non-contractual customer relationships, as per IFRS 3 Business Combinations.

References (to familiarise yourself with the subject):

– Customer contracts and the related customer relationships
– Non-contractual customer relationships
– Order or production backlog

What are the inputs to the model?

Revenue

Revenue – represents revenue from existing customer relationships for existing products. Includes contractual and non-contractual relationships (even those without current backlog or commitments). Separate valuation of a backlog revenue intangible asset can be considered if and when such backlog exists.

The model assumes a “market participant” point of view, therefore revenue/earnings … Read more