IRR Calculator

The Internal Rate of Return (IRR) Calculator computes the annual rate of return that will be earned on an investment based on its cash flows. By entering the amount already paid and the payments that the project will pay back annually or at equal intervals, it calculates a single interest rate at which the entire cash flow breaks even. In addition to the IRR, you also get supporting data such as net present value (based on your specified minimum return), a clear decision for approval or rejection, payback period, profitability index and modified internal rate of return.

What is Internal Rate of Return?

The internal rate of return (IRR) is the discount rate at which the net present value of all cash flows equals zero. In other words, it's the interest rate that makes the break-even point when taking into account the time value of money.

A dollar you receive next year is worth less than a dollar received today because the money can be invested to earn interest. The IRR converts this time difference into an annual percentage rate. If a project's IRR exceeds the required return, then it generates profits that exceed costs and creates value. If the IRR falls below the required return, then the project does not meet requirements.

How to use this calculator:

First select how the cash flows will be received. If the amounts are different each year then select "Irregular Cash Flows" and enter the amount for each year. If the same amounts recur then select "Fixed Recurring Cash Flows" and set the amount per period, the duration, the frequency of payments and the final lump sum to be received at the end.

The initial investment is entered as a positive number. The tool treats it as a cash outflow in year zero. Set the required rate of return, also known as hurdle rate or cost of capital. The tool uses this value to calculate net present value (NPV) and determine if the project meets the specified hurdle. If you want to set your own reinvestment and financing rates, enable "custom IRR" option.

Formula for calculating internal rate of return (IRR):

The internal rate of return (IRR) is the interest rate at which the net present value equals zero.

where CF is the cash flow in period t. The initial investment is entered as a negative cash flow at time zero and n is the number of periods. Unlike many formulas, this equation cannot be directly solved for r. Since there is no closed-form solution, the tool calculates r iteratively. It tests different interest rates until it reaches NPV = 0. This tool also uses the same search method.

Suppose you invest $40,000 and receive $10,000, $20,000 and $30,000 in the next three years. The IRR is the interest rate that satisfies the following condition:

The result shows that the IRR is approximately 19.44 percent. If the cost of capital is 12 percent, this result is well above the hurdle rate and makes the project very attractive. If the cost of capital is 20 percent, then the same value of 19.44 percent is just below the hurdle rate.

The symbols below are used in the calculations.

Relationship between IRR and NPV

The internal rate of return (IRR) and net present value (NPV) are derived from the same cash flows and answer related questions. The NPV shows how much a project is worth at a chosen interest rate in terms of today's money. The IRR gives the interest rate at which that surplus would be exactly zero.

For typical projects - those with initial costs followed by benefits - the two measures will agree. If IRR is higher than the required rate of return, then NPV calculated at the required rate of return will be positive. This tool shows both values simultaneously so you can see the size of an opportunity in dollar terms and its ranking in percentage terms.

Why IRR can be better than simple return

Suppose there are two projects each with a cost of $100,000 and total returns of $150,000 over five years. Both have a simple return of 50 percent but if one pays out faster than the other then their performance is different.

Suppose the first project has cash flows of 5,000, 20,000, 25,000, 40,000 and 60,000 while the second project has cash flows of 0, 10,000, 30,000, 30,000 and 80,000. If you enter each cash flow into an irregular series mode, the IRR for the first project is about 11.29 percent while it's about 10.26 percent for the second project. Because money received earlier can be reinvested sooner, a project with earlier cash flows wins out even if the total amounts are equal. This insight into timing is what makes IRR capture something that simple return often misses.

Interpretation of results based on minimum interest rate

The usual rule is clear: if a project's IRR exceeds the required rate of return it will be accepted; otherwise it will be rejected. When comparing multiple projects, a higher IRR generally indicates more efficient use of capital, but this isn't the only factor to consider.

The required rate of return should be set realistically. It must reflect the cost of capital and risk of cash flows. Speculative projects should have a higher minimum rate than those with stable contractually guaranteed income.

IRR limitations

The IRR is useful but not a complete indicator. It ignores the size of a project so that a small investment with a high IRR may make less overall profit than a larger investment with a lower IRR. The IRR alone does not reveal risk, therefore a lower but safe IRR could be better than a higher but risky IRR.

The internal rate of return (IRR) assumes that the cash flows will be reinvested at the IRR itself, which is often an overly optimistic assumption. If the cash flows change signs more than once, for example in the order negative, positive, negative, there can be multiple IRRs, leading to ambiguous interpretation. The modified IRR options allow clear reinvestment and financing rates to be specified, solving the reinvestment problem and giving a single unambiguous rate of return. In practice analysts do not rely on a single number but interpret the IRR together with net present value (NPV), payback period and the modified IRR.

Fields of application for the IRR:

Companies use the IRR as part of their capital budgeting to evaluate and prioritize investments such as buying equipment, expanding a business or launching new lines of business based on expected returns. Private equity and venture capital firms use the IRR to show the performance of their funds or transactions over time. Real estate investors incorporate purchase prices, rental income, expenses and potential sale proceeds into one number for comparative analysis. Lenders and analysts use the IRR to compare loan and lease offers.

This calculator is for general informational and planning purposes only and does not constitute financial advice. The projected cash flows are estimates only and returns cannot be guaranteed. Actual results may vary depending on circumstances, market conditions and timing. Please consult a qualified professional before making any investment decisions.