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Internal Rate of Return (IRR) Calculator

Calculates the discount rate at which the net present value (NPV) of all cash flows from a particular project equals zero.

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Internal Rate of Return

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Overview

The Internal Rate of Return (IRR) is a capital budgeting metric used to estimate the profitability of potential investments. It represents the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. A project is generally considered acceptable if its IRR is greater than the company's required rate of return or cost of capital, as it indicates the project is expected to generate value.

Symbols

Variables

CF_t = Cash Flow at time t, IRR = Internal Rate of Return, t = Time Period, n = Total Number of Periods

Cash Flow at time t
$
IRR
Internal Rate of Return
%
Time Period
years
Total Number of Periods
years

Apply it well

When To Use

When to use: Use IRR to evaluate the attractiveness of investment projects, especially when comparing multiple projects with different cash flow patterns. It's particularly useful for capital budgeting decisions where a clear hurdle rate (cost of capital) is established. Ensure all relevant cash inflows and outflows are accurately estimated over the project's life.

Why it matters: IRR is a crucial tool for investment appraisal, helping businesses and investors make informed decisions about allocating capital. It provides a single, easily understandable percentage return that can be compared against a company's cost of capital or other investment opportunities, guiding strategic growth and resource deployment.

Avoid these traps

Common Mistakes

  • Incorrectly handling initial investment as a negative cash flow at t=0.
  • Ignoring the possibility of multiple IRRs for non-conventional cash flow streams.
  • Comparing IRR to an inappropriate benchmark instead of the cost of capital.

One free problem

Practice Problem

A project requires an initial investment of 30,000 in year 1, $40,000 in year 2, and a final cash flow in year 3. If the project's Internal Rate of Return (IRR) is 10%, what is the cash flow in year 3?

CF_0-100000
CF_130000
CF_240000
Internal Rate of Return0.1 %
Total Number of Periods3 years

Solve for: IRR

Hint: Remember to discount each cash flow back to time zero using the given IRR.

The full worked solution stays in the interactive walkthrough.

References

Sources

  1. Brealey, R. A., Myers, S. C., & Allen, F. (2020). Principles of Corporate Finance (13th ed.). McGraw-Hill Education.
  2. Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2022). Fundamentals of Corporate Finance (13th ed.). McGraw-Hill Education.
  3. Wikipedia: Internal Rate of Return
  4. Ross, S. A., Westerfield, R. W., & Jaffe, J. F. (2019). Corporate Finance (12th ed.). McGraw-Hill Education.
  5. Brealey, Richard A., Myers, Stewart C., and Allen, Franklin. Principles of Corporate Finance. McGraw-Hill Education.
  6. Ross, Stephen A., Westerfield, Randolph W., and Jaffe, Jeffrey F. Corporate Finance. McGraw-Hill Education.
  7. Brigham, Eugene F., and Houston, Joel F. Fundamentals of Financial Management. Cengage Learning.
  8. Brealey, Myers, & Allen, Principles of Corporate Finance, 13th Edition, McGraw-Hill Education.