What is the meaning / definition of Internal Rate of Return in the hospitality industry?
IRR stands for: Internal Rate of Return.
The Internal Rate of Return is a financial indicator, used to determine the attractiveness of an investment or project. It can be defined as the percentage rate earned on each dollar invested, in a defined period of time. It compares expected cash flow of a project to the cost of the capital involved.
A hotelier can use IRR when deciding between renovating several rooms, in order to fetch a higher price or keeping the original ones. If the IRR of a new project exceeds a company’s required rate of return, the project is desirable. If IRR is under the required rate of return, the project should be rejected. The required rate of return is set by the organization and can way in and consider all efforts required to deliver the project. It thereby manifests what required rate of return is the minimum return, an investor can expect to achieve when investing into the project.
The Internal Rate of Return can also be discribed as a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
How to calculate the IRR?
The formula is pretty complex and usually computerized, but it looks like this:
0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively.
- NPV – Net Present Value
- DCF – Discounted Cash Flow
- Discount Rate