IRR Calculation and Formulas

IRR Calculation and Learning Material PDF

Internal Rate of Return Calculation and Tips/ Formulas:

The IRR is the interest rate (also known as the discount rate) IRR Calculation and Formulasthat will bring a series of cash flows (positive and negative) to a net present value (NPV) of zero (or to the current value of cash invested). Using IRR to obtain net present value is known as the discounted cash flow method of financial analysis. Download IRR Calculation and Learning Material PDF from here..

What is Internal Rate of Return-IRR

Internal rate of return (IRR) is a metric used in capital budgeting measuring the profitability of potential investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.

Formula for Calculating Internal Rate of Return- IRR

The following is the formula for calculating NPV:


Ct = net cash inflow during the period t

Co= total initial investment costs

r = discount rate, and

t = number of time periods

To calculate IRR using the formula, one would set NPV equal to zero and solve for the discount rate r, which is here the IRR. Because of the nature of the formula, however, IRR cannot be calculated analytically, and must instead be calculated either through trial-and-error or using software programmed to calculate IRR.

Generally speaking, the higher a project’s internal rate of return, the more desirable it is to undertake the project. IRR is uniform for investments of varying types and, as such, IRR can be used to rank multiple prospective projects a firm is considering on a relatively even basis. Assuming the costs of investment are equal among the various projects, the project with the highest IRR would probably be considered the best and undertaken first.

Uses of IRR:

i. Profitability of an Investment:

Organizations use IRR in capital budgeting to compare the profitability of capital projects in terms of the rate of return. For example, an organization will compare an investment in a new plant versus an extension of an existing plant based on the IRR of each project. To maximize returns, the higher a project’s IRR, the more desirable it is to undertake the project. If all projects require the same amount of up-front investment, the project with the highest IRR would be considered the best and undertaken first.

ii. Maximizing Net Present Value:

The internal rate of return is an indicator of the profitability, efficiency, quality, or yield of an investment. This is in contrast with the net present value, which is an indicator of the net value or magnitude added by making an investment.

iii. Fixed Income:

IRR is also used to calculate yield to maturity and yield to call.
iv. Capital Management:
Organizations use internal rate of return to evaluate share issues and stock buyback programs. A share repurchase proceeds if returning capital to shareholders has a higher internal rate of return than candidate capital investment projects or acquisition projects at current market prices.
v. Private Equity:
IRR can also used for private equity, from the limited partners’ perspective, as a measure of the general partner’s performance as investment manager. This is because it is the general partner who controls the cash flows, including the limited partners’ draw-downs of committed capital.
Calculations of IRR with Examples:

If an investment may be given by the sequence of cash flows

Cash flow
0 -123400
1 36200
2 54800
3 48100




then the IRR of a given project would be:

In this case, the answer is 5.96% (in the calculation, that is, r = .0596).

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