IRR Formula:
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The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. It's a key metric used in capital budgeting to evaluate the profitability of potential investments.
The calculator uses the IRR formula:
Where:
Explanation: The IRR is found by solving for the discount rate (r) that sets the sum of discounted cash flows equal to zero, indicating the break-even rate of return.
Details: IRR helps investors compare the profitability of different investment opportunities. A higher IRR generally indicates a more desirable investment, assuming similar risk profiles and investment horizons.
Tips: Enter cash flows as comma-separated values (e.g., -1000,300,400,500) and corresponding time periods in years (e.g., 0,1,2,3). The first cash flow is typically negative (initial investment).
Q1: What is a good IRR?
A: Generally, an IRR above the company's cost of capital is considered good. For most investments, IRR > 10-15% is typically desirable.
Q2: How does IRR differ from ROI?
A: ROI shows total return percentage, while IRR accounts for the time value of money and provides the annualized rate of return.
Q3: What are the limitations of IRR?
A: IRR may give misleading results for non-conventional cash flows and doesn't account for project scale. It assumes reinvestment at the IRR rate.
Q4: When should I use IRR vs NPV?
A: Use IRR for comparing projects of similar size and duration. Use NPV for absolute value assessment and when cash flow patterns are unconventional.
Q5: Can IRR be negative?
A: Yes, a negative IRR indicates the investment would lose money, with the cash outflows exceeding the discounted inflows.