A basic criteria for a good investment is that
it have a positive Net Present Value (see the previous page on Net
Present Value). A second, related criteria is that the investment have an Internal
Rate of Return that exceeds the economy’s rate of interest, r.

The Internal Rate of Return is the
rate of interest than an investment pays on your money. As a consequence, if we
calculate an investment’s Net Present Value using its Internal Rate of Return
as the interest rate, the investment will just break even – that is, its Net
Present Value = 0.

When we calculate an investment’s Net
Present Value using the economy’s rate of interest, r, the investment’s Net
Present Value will be positive only if the rate of interest it pays you – its
Internal Rate of Return – is larger than the economy’s rate of interest.

Below, we have expanded the Net Present
Value calculator of the previous page to include a calculation of an
investment’s Internal Rate of Return. The diagram shows the Net Present Value of
the investment you have entered using different interest rates. The interest
rate that causes the investment’s Net Present Value to be zero is the
investment’s Internal Rate of Return.

Using the investment numbers in the
table, substitute the Internal Rate of Return for the interest rate used to
calculate the Net Present Value. Observe the Net Present Value when this new
interest rate is used. Then experiment with your own investment project and
economy rate of interest to explore the relationship between an investment’s
Net Present Value, its President Discounted Value and the economy’s rate of
interest.