Internal Rate of Return (IRR) -The Trick of Monthly Installment with Low Annual Interest Rate

Annual Interest Rate: 8%
Amount of Loan: $10,000
Annual Interest: $800
Total load (plus interest) = $10,800
Divided by 12 months,
monthly payment: 10800/12 = $900

Does it look like very usual for you about your monthly installment plan?

Be careful!!

Let’s REVERSE ENGINEERING it by using Internal Rate of Return!!!

Let’s say, you are going to invest $10,000 with return of $900 monthly for 12 month, what is the internal rate of return (IRR) of this investment?

Let AW = 900, PW = 10,000, n = 12, IRR = r = unknown.

Then, we have PW = AW*((r+1)^n-1)/(r*(r+1)^n)

Or

simply PW = AW(P|A,IRR,12)) (P|A,IRR,12)

(P|A,IRR,12)  = PW/AW = 11.1111

From the time value of money table:
(P|A,1%,12) = 11.255
(P|A,2%,12) = 10.575

So, obviously, IRR is between the values of 1% to 2%.

By using interpolation computation method: (11.255 – 10.575)/(1-2) = (11.1111 – 10.575)/(IRR – 2) -0.68 = 0.5361(IRR – 2) IRR = 1.2116%

So, monthly interest rate of return is 1.2116% or annual return of 14.5394% (12 multiple by 1.2116)

From this case study, we learn few things:
1. No Free Lunch In This World
2. Always Think In Different Perspectives
3. Always Think about IRR That's all for today.

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Written by: Xaivier Chia

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