The internal rate of return, IRR, is the actual percentage return on an investment. When organizations use the IRR as an investment criteria, they frequently set a required IRR that is greater than, or at least equal to, the return the organization could obtain through conventional investments such as the money market.
Let's return to the clinic investment example to determine the IRR for each of the investment options, Clinic A or Clinic B. Similar to calculating the NPV, we can use the IRR formula function in excel to determine the IRR for each Clinic scenario.
You will need to input the cash flows into the Values box, starting with the initial investment of negative (for cash outflow) $1,000,000. Next, Excel asks you to guess what IRR you think is reasonable. If you do not enter a guess, the program will assume a 10% IRR. From the Excel help menu:
"Microsoft Excel uses an iterative technique for calculating IRR. Starting with guess, IRR cycles through the calculation until the result is accurate within 0.00001 percent. If IRR can't find a result that works after 20 tries, the #NUM! error value is returned."
Each of the Clinic investment options provides a very high IRR. The two IRRs (24% and 23%) are also close in value.
Again, what other factors should the medical center leadership team consider as they make this investment decision?