# Importance of Calculating IRR in a Host Country

by Walter Johnson

International investment is fraught with both opportunity and risk. The benefits expected from investing overseas are often canceled out by the problems it creates. A host country is a country that is a recipient of foreign investment, and it expects certain benefits in exchange for permitting local access. Of course, the corporation investing expects profits and market access. Under many circumstances, the game between the host country and the corporation can be mutually beneficial.

## Internal Rate of Return

Internal rate of return (IRR) is a fairly complex, but common way of comparing different investment options. It measures an expected or acceptable profit against the initial cost of production. Other variables, however, are equally important. Interest rates, compound interest accumulation, the length of the investment commitment, and basic cash flow over time are all part of the IRR equation. In very general terms, the IRR equation measures rates of profit if the present value of today's investment in a host country is zero. This means that it measures return only and does not deal with present values, or the initial book value of investments. It is only concerned with profits.

## Host States

A host country usually requires something that the investing firm can provide. It is usually tax revenue, technological ability and infrastructural improvement. In developing countries, the IRR equation becomes far more important and significant in deciding on the place, method and type of investment. The importance of IRR in these kind of locations revolves around the question of stability.

## Macroeconomics

If an American firm wants to invest in a bauxite mines in Hungary, the IRR will tell the firm if such an investment is worthwhile. One of the most important things the IRR will measure is the projected rate of return relative to the stability of the country. If Hungary is seeing a fluctuation in its interest rates due to trade issues, it is possible that this investment is a bad idea. On the other hand, the importance of bauxite to the world economy might suggest cash flows that balance any instability in rates.

## Time Periods

Another significant aspect of the IRR is its measurement of the amount of time the investment will have to mature. Using the Hungarian bauxite example, an investment of eight years might look much better than a short-term investment of two years. This is because interest rates often balance out over time, and therefore, the initial problem of interest-rate fluctuation will no longer matter once the commitment is lengthened. When all these variables are included in different equations representing different investment options, the score can let the firm know which options, and under which circumstances, are the best for the firm.