Internal Rate of Return (IRR)
Calculate IRR from a series of cash flows to evaluate project or investment performance and compare alternatives.
An Introduction to Internal Rate of Return (IRR)
Discover the "magic number" that tells you the true potential return of an investment.
What on Earth is IRR?
Imagine you have two options: put $10,000 into a project, or put it in a high-yield savings account.
The Internal Rate of Return (IRR) is the interest rate that savings account would need to have for you to end up with the exact same amount of money as your project would generate over its lifetime.
In simple terms, IRR is the inherent growth rate of your investment. It’s the percentage return you are earning on the money invested in the project.
Related Investment Analysis
Use IRR together with these tools to make stronger decisions:
- Net Present Value (NPV) — Measures absolute value created. Prefer NPV when choosing between mutually exclusive projects.
- Profitability Index (PI) — Scales value by investment size; helpful under capital rationing.
- Return on Investment (ROI) — Simple profitability ratio; good for quick comparisons but ignores time.
The Link Between IRR and NPV
IRR and Net Present Value (NPV) are two sides of the same coin. Remember how NPV tells you how much value a project adds in today's dollars? The key insight is: The IRR is the specific discount rate that makes the NPV of a project exactly zero. It's the "break-even" point.
Find the IRR for the Coffee Cart
Adjust the discount rate slider. Watch how the NPV changes. Can you find the rate that makes the NPV as close to $0 as possible? That's the IRR!
With a discount rate of 5.0%, the project's NPV is...
$804.45
How to Use IRR: The Decision Rule
The decision rule for IRR is beautifully simple. You compare the project's IRR to your "Hurdle Rate."
The Hurdle Rate is just your minimum acceptable rate of return. It could be your company's cost of capital, the interest rate on a loan, or simply the return you could get from another investment (like an index fund).
Accept Project
IRR > Hurdle Rate
The project's expected return is higher than your minimum requirement. This is a green light!
Reject Project
IRR < Hurdle Rate
The project's return is not enough to justify the investment. You have better places to put your money.
IRR in Practice: Strengths & Cautions
Strengths of Using IRR
- Easy to Understand: Everyone gets percentages. Saying a project has an "18% IRR" is more intuitive for many than saying it has an "NPV of $4,321."
- Compares Different Sized Projects: It provides a single percentage that helps compare a small project with a large one based on their relative return efficiency.
- Accounts for Time Value: Like NPV, it properly values money based on when you receive it.
Cautions and Limitations
- Reinvestment Assumption: IRR assumes that all cash flows are reinvested at the IRR itself. This can be unrealistic, especially for projects with very high IRRs.
- Multiple or No IRR: Projects with unconventional cash flows (e.g., a big cost in the middle) can have multiple IRRs or no IRR at all, causing confusion.
- Mutually Exclusive Projects: When choosing between two projects where you can only pick one, the one with the higher IRR is not always the one that adds more absolute value (NPV is better for this choice).
How to use the Internal Rate of Return (IRR)
Follow these steps to get accurate results with the internal rate of return (irr).
- 1
Enter your values
Fill in the required input fields above. Units can be changed where available.
- 2
Click Calculate
Press the calculate button to compute results instantly in your browser.
- 3
Review your results
View the computed outputs and use related calculators for deeper analysis.
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