What does IRR tell you?

IRR is the expected compound annual rate of return that an investment will generate. In simpler terms, it's the rate of growth a project is expected to generate. * Decision Rule: Generally, if the IRR of a new project is higher than a company's required rate of return (often its cost of capital), that project is considered a good investment. * Comparison Tool: IRR is very useful for comparing the profitability of multiple different projects or investments. A project with a higher IRR is generally considered more desirable.

How is IRR Calculated?

There is no analytical formula to solve for IRR. It must be found through an iterative numerical process, essentially trial-and-error. The goal is to find the discount rate (`r`) that satisfies the following equation: `NPV = Σ [ Cash Flow / (1 + r)^t ] = 0` Where: * t is the time period of the cash flow. * Cash Flow is the cash flow at time `t`. The initial investment is a negative cash flow at `t=0`. This calculator uses a numerical method (the Newton-Raphson method) to find the value of `r` that makes the NPV zero.

IRR vs. NPV (Net Present Value)

IRR and NPV are closely related but provide different insights: * NPV gives you a dollar value, representing the total value a project is expected to add to the company. * IRR gives you a percentage return. While IRR is popular for its simplicity (it's a single percentage), NPV is often considered theoretically superior because it provides a direct measure of how much value is created. It's also more reliable when comparing mutually exclusive projects or projects with unconventional cash flows (e.g., multiple sign changes).

* Multiple Solutions: For projects with non-conventional cash flows (e.g., a large negative cash flow in the middle of the project), there can be multiple IRR values, making the metric ambiguous. * Reinvestment Assumption: IRR implicitly assumes that all positive cash flows generated by the project are reinvested at the IRR rate itself. This can be an unrealistic assumption.

Calculator Pro

Compound Interest Calculator

Visualize how your investments can grow over time with the power of compound interest.

Cash Flows

Enter the initial investment (as a negative number) and subsequent cash inflows.

Year 0

Year 1

Year 2

Year 3

Year 4

Internal Rate of Return (IRR)

10.48%

NPV Profile

This chart shows the Net Present Value (NPV) at different discount rates. The IRR is the rate where the NPV is zero.

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