What is internal rate of return?
Internal rate of return (IRR) is the yearly rate of return at which the net present value (NPV) of all of an investment’s cash flows equals zero. Put simply, it is the single interest rate that makes the money you put in and the money you get back balance out, taking timing into account. This IRR Calculator is useful for investors, business owners and students comparing projects, rental properties or any investment with several payments over time.
How to use it
- Fixed cash flow: enter the initial investment, how long you held it, the ending balance and any regular deposit or withdrawal with its timing, then click Calculate.
- Irregular cash flow: enter the initial investment and the cash flow for each year (use a minus sign for money you put in), then click Calculate.
IRR formula
IRR is the rate that solves:
0 = Σ (t = 0 to n) CFt ÷ (1 + IRR)^t
where CFt is the cash flow in year t (the initial investment at t = 0 is negative), and n is the last year. There is no simple closed-form answer, so the calculator tries rates repeatedly until the sum is zero.
Example
You invest $10,000 today and receive $3,000 at the end of each year for 5 years. The rate that makes the present value of the five $3,000 payments equal $10,000 is about 15.2%, so the IRR is about 15.2% a year. You received $15,000 in total, a $5,000 gain, but IRR also reflects that the money came back gradually rather than all at once.
Why use an IRR calculator?
Working out IRR by hand takes trial and error. The calculator does the iteration instantly, so you can compare projects or investments with different sizes and timing on the same yearly-rate basis.
Why Is IRR Important for Investments?
IRR gives investors a single percentage that can be used to evaluate and compare different opportunities. For example, if one project has an IRR of 12% and another has an IRR of 8%, the first project may appear more attractive if both have similar risk and investment requirements. However, IRR should not be viewed independently because the size of the investment, timing of returns, risk, and total profit can all affect the overall quality of an investment.
IRR is particularly useful in capital budgeting, where businesses need to decide which projects deserve funding. It can also be applied to equipment purchases, business expansions, real estate investments, private equity projects, and other opportunities involving multiple cash inflows and outflows.
Common uses of IRR
Businesses use IRR to rank projects and equipment purchases. Real estate investors use it to combine the purchase price, yearly rental cash flow and sale proceeds into one return figure. Individuals can use it to check the real return on an investment where they added or withdrew money along the way.
Tips
- Compare IRR with your required return or borrowing cost; a project should beat it.
- Look at NPV as well. A small project can have a high IRR but add little in dollars.
- Be careful when cash flows switch sign more than once; there can be more than one IRR.
Frequently Asked Questions
IRR stands for Internal Rate of Return. It is the discount rate that makes the net present value of an investment’s cash flows equal to zero.
A good IRR depends on the investment’s risk, duration, and required rate of return. Generally, an IRR above the project’s required return or cost of capital may indicate a potentially attractive investment.
Neither metric is always better. ROI provides a straightforward measure of overall gain, while IRR considers the timing of cash flows and expresses the result as an annualized rate.
Yes. A negative IRR can occur when an investment’s cash flows are insufficient to recover the initial investment. This may indicate that the project is expected to lose money under the assumptions used.
Multiple IRRs can occur when cash flows repeatedly switch between positive and negative values. In these situations, additional measures such as NPV or modified IRR may provide a clearer evaluation.
Disclaimer: This calculator gives estimates for general information only. It is not financial, tax or legal advice. Results depend on the numbers you enter and on simplified assumptions, so your actual figures may differ. Check important decisions with a qualified professional or the official source.
Related Calculators
To look at an investment from other angles, these return and time-value calculators may help.