What is IRR (Internal Rate of Return)?
The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular investment equal to zero. It represents the expected compound annual rate of return that will be earned on a project or investment.
How IRR is Calculated
IRR is found by solving the following equation for r:
0 = Σ [ CF_t / (1 + r)^t ]
Where:
- CF_t = Cash flow at time t
- r = Internal Rate of Return
- t = Time period
This equation is typically solved using numerical methods such as the Newton-Raphson method because there is no closed-form solution.
How to Use This Calculator
- Enter your Initial Investment (this is treated as a negative cash flow at time 0).
- Add periodic cash flows for each year/period (positive for inflows, negative for additional investments or outflows).
- Click Calculate IRR.
- View the resulting IRR percentage and breakdown chart.
Important Notes
- IRR assumes that all interim cash flows are reinvested at the same rate as the IRR itself (this is a known limitation).
- Projects with non-conventional cash flows (multiple sign changes) may have multiple IRRs.
- Always compare IRR with your required rate of return or cost of capital.