Businesses calculate a variety of numbers when they analyze their financial activities. These include using capital investment analysis techniques and measuring their income. Capital investment analysis techniques allow companies to choose between multiple investment options, and decide which investments to fund. Income measurement allows the company to evaluate the performance of past investments. The internal rate of return (IRR), and the yield to maturity represent two different calculations performed by company management.
The internal rate of return refers to a technique used to evaluate capital investments. This technique calculates the interest rate earned on an investment when all cash flows are converted into present value numbers. The company lists each cash flow, and calculates the interest rate used to create a present value of zero. This interest rate equals the internal rate of return. A higher IRR refers to greater earnings from the project.
Yield To Maturity
The yield to maturity refers to the earnings a company records on its investments. These earnings include capital gains and interest income. Companies only calculate a yield to maturity on debt securities. The yield to maturity depends on the actual price the company pays for the investment.
The internal rate of return and yield to maturity calculations serve different purposes in the organization. The internal rate of return provides the company with information as it decides whether or not to pursue a particular investment. Companies use the IRR to compare multiple projects and determine which provides the greatest return. The yield to maturity allows a company to determine its earnings on an investment. Companies use the yield to maturity to calculate the value of an investment they currently hold or anticipate holding.
Another difference between the internal rate of return and the yield to maturity involves the timing of the calculation. Companies calculate the internal rate of return prior to making the investment. This allows the company to use the information before it makes the decision to invest. Companies calculate the yield to maturity after making the investment. This allows the company to measure its earnings.