IRR Calculator
Enter expected cash inflows for each year (Year 1, Year 2, etc.)
IRR Decision Rule
Accept if:
IRR > Required Return
Reject if:
IRR < Required Return
Key Metrics
IRR
Rate where NPV = 0
NPV
Present value of all cash flows
Profitability Index
PV of inflows / Investment
Understanding Internal Rate of Return
What is IRR?
The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows equal to zero. It represents the expected annual rate of growth an investment is projected to generate.
IRR Formula Concept
IRR is the rate (r) that satisfies: 0 = Initial Investment + CF1/(1+r) + CF2/(1+r)^2 + ... + CFn/(1+r)^n
This equation cannot be solved algebraically and requires iterative methods.
IRR vs Other Metrics
| Metric | What It Measures | Advantage | Limitation |
|---|---|---|---|
| IRR | Rate of return | Easy to compare | Assumes reinvestment at IRR |
| NPV | Dollar value added | Shows absolute value | Requires discount rate |
| ROI | Total return percentage | Simple calculation | Ignores time value |
| Payback | Time to recover | Simple, focuses on risk | Ignores cash after payback |
When to Use IRR
IRR Works Best For:
- - Comparing projects of similar size
- - Projects with conventional cash flows
- - Capital budgeting decisions
- - Setting hurdle rates
IRR Limitations:
- - Multiple IRRs possible with unusual cash flows
- - Ignores project size (scale)
- - Assumes reinvestment at IRR rate
- - May conflict with NPV rankings
Example Analysis
Project Comparison
Project A
Investment: $100,000
Cash Flows: $30K, $35K, $40K, $45K
IRR: 15.2%
Project B
Investment: $50,000
Cash Flows: $20K, $20K, $20K
IRR: 9.7%
While Project A has a higher IRR, consider that it requires twice the investment. NPV analysis may give different rankings depending on your cost of capital.
Common Hurdle Rates
Conservative
8-10%
Low-risk projects
Moderate
12-15%
Average business risk
Aggressive
20%+
High-risk ventures
Professional Tip
Use multiple metrics (IRR, NPV, Payback, PI) together for better investment decisions. IRR alone can be misleading, especially when comparing projects of different sizes or with non-conventional cash flow patterns.
Frequently Asked Questions
What is IRR and how is it used?
Internal Rate of Return (IRR) is the discount rate that makes the net present value of all cash flows equal to zero. It represents the expected annual return of an investment. If IRR exceeds your required return (hurdle rate), the investment may be worthwhile. IRR is commonly used in capital budgeting and real estate analysis.
What is the difference between IRR and ROI?
ROI (Return on Investment) measures total return as a percentage of the initial investment, ignoring the time value of money. IRR accounts for the timing of cash flows, expressing return as an annual rate. A project with 50% ROI over 5 years has a different IRR than one with 50% ROI over 2 years. IRR is more accurate for comparing investments with different timelines.
What is a good IRR for an investment?
A 'good' IRR depends on the risk and alternative investments. Conservative projects might target 8-10% IRR, average business investments 12-15%, and high-risk ventures 20%+. The investment should exceed your cost of capital (what you could earn elsewhere with similar risk). Real estate typically targets 15-20% IRR, venture capital targets 25%+.
What are the limitations of IRR?
IRR has several limitations: it can produce multiple results with unconventional cash flows, it ignores project size (scale), and it assumes reinvestment at the IRR rate. IRR may also conflict with NPV rankings when comparing mutually exclusive projects. Use IRR alongside NPV, payback period, and profitability index for better decisions.