How to Calculate Internal Rate of Return with Salvage Value
The Internal Rate of Return (IRR) is a critical metric in capital budgeting used to estimate the profitability of potential investments. Unlike a standard IRR calculation that assumes the asset becomes worthless at the end of the term, calculating IRR with a Salvage Value accounts for the residual value of the asset when the project or holding period ends. This provides a more accurate reflection of the investment's true yield, particularly for assets like real estate or heavy machinery that retain significant value.
Please enter valid numeric values for all fields.
Assumes constant cash flow per year.
The resale value at the end of the duration.
Internal Rate of Return (IRR)
0.00%
Calculation Breakdown:
Total Return (Cash Flows + Salvage): $0
Net Profit: $0
function calculateIRRWithSalvage() {
// 1. Get Elements
var investmentInput = document.getElementById("initialInvestment");
var cashFlowInput = document.getElementById("annualCashFlow");
var yearsInput = document.getElementById("projectYears");
var salvageInput = document.getElementById("salvageValue");
var resultDiv = document.getElementById("result-container");
var irrDisplay = document.getElementById("irrResult");
var totalReturnDisplay = document.getElementById("totalReturnDisplay");
var netProfitDisplay = document.getElementById("netProfitDisplay");
var errorDiv = document.getElementById("error-message");
// 2. Parse Values
var investment = parseFloat(investmentInput.value);
var annualFlow = parseFloat(cashFlowInput.value);
var years = parseInt(yearsInput.value);
var salvage = parseFloat(salvageInput.value);
// 3. Validation
if (isNaN(investment) || isNaN(annualFlow) || isNaN(years) || isNaN(salvage) || investment <= 0 || years <= 0) {
errorDiv.style.display = "block";
resultDiv.style.display = "none";
return;
}
errorDiv.style.display = "none";
// 4. Calculation Logic: IRR requires iterative approximation
// The formula is: 0 = -Investment + (CashFlow / (1+r)^1) + … + ((CashFlow + Salvage) / (1+r)^n)
var low = -0.9999; // Lower bound (-99.99%)
var high = 100.0; // Upper bound (10000%) – unlikely to be higher
var epsilon = 0.00001; // Precision
var limit = 1000; // Max iterations
var guess = 0;
var npv = 0;
var found = false;
// Binary Search / Bisection Method for finding r (IRR)
for (var i = 0; i < limit; i++) {
guess = (low + high) / 2;
npv = 0;
// NPV Formula implementation
// Initial Outlay (Negative at t=0)
npv += -investment;
// Add Annual Cash Flows
for (var t = 1; t <= years; t++) {
var cashFlowAtT = annualFlow;
// Add Salvage Value to the final year
if (t === years) {
cashFlowAtT += salvage;
}
npv += cashFlowAtT / Math.pow(1 + guess, t);
}
// Check if we are close enough to 0
if (Math.abs(npv) 0) {
// If NPV is positive, the rate is too low
low = guess;
} else {
// If NPV is negative, the rate is too high
high = guess;
}
}
// 5. Calculate Summary Metrics
var totalCashInflow = (annualFlow * years) + salvage;
var netProfit = totalCashInflow – investment;
// 6. Display Results
var irrPercentage = (guess * 100).toFixed(2);
irrDisplay.innerHTML = irrPercentage + "%";
totalReturnDisplay.innerHTML = "$" + totalCashInflow.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2});
netProfitDisplay.innerHTML = "$" + netProfit.toLocaleString(undefined, {minimumFractionDigits: 2, maximumFractionDigits: 2});
resultDiv.style.display = "block";
}
Understanding the Formula
The calculation of IRR involves finding the discount rate ($r$) that sets the Net Present Value (NPV) of all cash flows to zero. When a salvage value is involved, it is treated as an additional cash inflow occurring in the final period of the project.
The mathematical formula solved by this calculator is:
0 = -C0 + Σ [ Ct / (1+r)t ] + [ SV / (1+r)n ]
C0: Initial Investment (Outflow)
Ct: Net Cash Flow for period t
SV: Salvage Value (Terminal Value)
n: Total number of periods (Years)
r: Internal Rate of Return (the variable we solve for)
Why Include Salvage Value?
Ignoring salvage value is a common mistake that leads to underestimating the profitability of an investment. In scenarios such as buying a delivery truck, real estate investing, or purchasing manufacturing equipment, the asset rarely depreciates to zero market value by the time you sell it or finish the project.
Example Scenario
Imagine you purchase a machine for $50,000. It generates $8,000 a year in savings. If you calculate IRR based solely on 5 years of savings, the return looks poor (negative NPV). However, if you can sell the machine for $20,000 at the end of Year 5, that large influx of cash significantly boosts the IRR, turning a potentially rejected project into an accepted one.
Factors Influencing the Result
The output of the IRR with Salvage Value Calculator is highly sensitive to:
Holding Period: The longer you hold the asset, the further away the salvage value is in time, which reduces its present value impact on the IRR due to discounting.
Magnitude of Salvage Value: A higher resale value directly increases the total return and the IRR.
Timing of Cash Flows: Cash flows received earlier in the project have a higher impact on IRR than those received later.
How to Interpret the Result
Once you calculate the IRR, compare it to your Hurdle Rate or Weighted Average Cost of Capital (WACC).
IRR > WACC: The project is expected to generate value and is generally considered a good investment.
IRR < WACC: The project may destroy value and should likely be rejected unless there are strategic reasons to proceed.