Internal Rate of Return (IRR)
|Net Cash Flow ($)|
Using the internal rate of reutrn (IRR) calculator
- Internal Rate of Return (IRR) - IRR is the rate to make NPV equal to zero in an investment.
- Initial Investment - Initial investment on the first year.
- Cash-In - Annual cash in-flows.
- Cash-Out - Annual cash out-flows.
- Net Cash Flow - Cash-in minus cash-out.
What is IRR (internal rate of return)
IRR is the rate of return that makes the NPV (net present value) equal to zero, IRR is also called effective interest rate, or rate of return. It is used to evaluate an investment or project. Typically the higher the IRR, the more possibility to undertake the project.
How to calculate IRR?
It is almost impossible to talk about IRR without mentioning NPV. NPV formula is as below:
Since IRR is the rate to make NPV=0, we get the below functions:
PV of benefits - PV of costs = 0
i is IRR, as the only unknown, it can be solved by using numerical or graphical analysis techniques.
Let's see the example:
An $85,000 investment returned $20,000 per year over a 5-year lifespan, what is the rate of return on the investment?
20000/(1+i) + 20000/(1+i)^2 + 20000/(1+i)^3 + 20000/(1+i)^4 + 20000/(1+i)^5 = 85000
IRR is 5.68%.
IRR vs NPV
IRR is a rate, a percentage, while NPV is an absolute value. IRR is usually used to calculate the profitability of an investment or a project. If the IRR is greater than the cost of capital, the investment or project may be accepted. Otherwise, it should be rejected. NPV is used to measure the total value that an investment will bring in during a given period. If NPV is greater than zero, the investment is usually considered to be acceptable.
Calculate IRR in Microsoft Excel
If you don't have internet access or feel more comfortable to work with Microsoft Excel, this tutorial video will teach you how to do it using Excel.