IRR Calculator
Summary
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What is the internal rate of return?
At its core, the internal rate of return is a discount rate at which the net present value (NPV) of a project’s cash flows equals zero. When investors or businesses undertake a project, they typically pay an initial cost (the investment) and may make additional investments as well as receive a series of returns (cash inflows) over time. Because money today is worth more than the same amount of money in the future, future cash flows need to be adjusted (or “discounted”) back to their present value. The internal rate of return is the specific discount rate that makes the project’s net present value exactly zero.
In other words, IRR is the “break-even” rate of return for an investment when considering the time value of money. If the IRR of a project is higher than the company’s required rate of return or the cost of capital, the project is generally considered worthwhile because it implies that the project will generate a return higher than its cost. Conversely, if the IRR is below the required rate of return, the project may not be viable, as it may not generate sufficient returns to justify the investment.
How is IRR calculated?
The formula for the internal rate of return is essentially the same as the net present value formula except that instead of calculating NPV for a given discount rate, we solve for the discount rate that sets NPV to zero. The net present value (NPV) equation for a series of cash flows can be written as,
where:
- CFt is the cash flow over period t. (Note that CF0 is typically negative if it represents the initial investment).
- r is the discount rate, or in this context, the IRR.
- t is the time period (from 0 to n).
To find the IRR, we adjust r until the sum of the present values of all cash inflows and outflows equals zero. In practice, this cannot be solved by simple algebraic manipulation for most real-world projects. Instead, analysts typically use financial calculators (such as the one provided above), spreadsheet software, or specialized financial tools that iteratively find the rate at which NPV equals zero.