Internal Rate of Return (IRR) Calculator
Calculated IRR
What is the Internal Rate of Return (IRR)?
The Internal Rate of Return (IRR) is a financial metric used by investors and businesses to estimate the profitability of potential investments. It is technically the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
In simpler terms, if you invest money today, the IRR is the annual percentage rate of return that your investment is expected to generate over its lifetime. The higher the IRR, the more desirable the investment.
How to Interpret IRR Results
IRR is usually compared against a company's "Hurdle Rate" or cost of capital. If the IRR exceeds the cost of capital, the project is generally considered a good investment. If it is lower, the project might result in a loss of value for the stakeholders.
Imagine you invest $10,000 to start a small business. Over the next three years, the business earns you $4,000, $4,500, and $5,000 respectively. Your IRR would be roughly 16.23%. This means your $10,000 investment grew at an effective annual rate of 16.23%.
The Math Behind the Calculation
Since IRR is the rate where NPV equals zero, the formula is:
0 = NPV = Σ [ CashFlowt / (1 + IRR)t ]
This calculator uses a numerical iteration method (the Newton-Raphson method) to solve for IRR, as there is no direct algebraic formula to calculate it when dealing with multiple periods.