Hand Calculate Internal Rate of Return (IRR)
What is Internal Rate of Return (IRR) and Why it Matters
Internal Rate of Return (IRR) is a metric used to evaluate the profitability of an investment. It represents the annualized effective compounded return rate that would result in a net present value of zero for the investment. In other words, it’s the discount rate at which the net present value of the investment equals zero.
IRR is a crucial tool for financial analysis as it helps in comparing the profitability of different investments, regardless of their size or duration.
How to Use This Calculator
- Enter the cash flows of your investment in the ‘Cash Flows’ field. Use commas to separate multiple cash flows.
- Click the ‘Calculate’ button.
- View the calculated IRR in the ‘Results’ section.
- Visualize the cash flows and IRR in the chart below.
Formula & Methodology
The IRR formula is based on the net present value (NPV) of the cash flows. The IRR is the discount rate ‘r’ that makes the NPV equal to zero:
NPV = ∑ [CFt / (1 + r)^t] – Initial Investment = 0
Where CFt is the cash flow in year t, and r is the discount rate (IRR).
Real-World Examples
Example 1: Investment in Stock
You invest $1000 in a stock that pays a $200 dividend after the first year and sells for $1200 after the second year.
Cash Flows: -$1000, $200, $1200
IRR: 15.87%
Data & Statistics
| Asset Class | Average IRR |
|---|---|
| Stocks | 10.3% |
| Bonds | 3.5% |
| Real Estate | 6.2% |
| Year | S&P 500 IRR | 10-Year Treasury IRR |
|---|---|---|
| 2020 | 18.4% | 0.9% |
| 2019 | 31.5% | 1.9% |
| 2018 | 0.0% | 2.7% |
Expert Tips
- Be cautious when using IRR for mutually exclusive projects. Use the NPV profile method instead.
- IRR assumes that cash flows can be reinvested at the IRR rate. This may not always be the case.
- IRR is sensitive to the scale of cash flows. Use the modified internal rate of return (MIRR) for better results.
Interactive FAQ
What is the difference between IRR and NPV?
IRR tells you the rate of return on an investment, while NPV tells you the net value of an investment.
Can IRR be negative?
Yes, if the initial investment is greater than the present value of the future cash flows.
Investopedia: Internal Rate of Return
SEC: Internal Rate of Return (IRR) Calculator