IAI Actuarial Core Principles · Actuarial Mathematics for Modelling · Equation of value
An investor pays Rs 10,00,000 now and receives Rs 5,50,000 at the end of year 1 and Rs 6,05,000 at the end of year 2. What is the internal rate of return, as an effective annual rate?
The internal rate of return is 10.00%. Discounting the two receipts at 10% gives Rs 5,00,000 each, which totals exactly the Rs 10,00,000 outlay, so the equation of value is satisfied at that rate.
- A7.75%
- B10.00%Correct
- C15.50%
- D5.00%
- 11.55%
Explanation
At i = 10%: 550,000/1.1 + 605,000/1.21 = 500,000 + 500,000 = 1,000,000, so the equation of value holds exactly. The IRR is therefore 10.00%. Rs 1,55,000 total profit on 10,00,000 gives 15.5%, and half of that gives 7.75%, but both ignore compounding and the timing of the cashflows.
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