Internal Rate of Return
The internal rate of return calculator facilitates the tricky calculation of IRR, as the concept of IRR is widely used for evaluating investments. IRR is a technique of discounting cash flows for analyzing investment decisions. It is the discount rate at which the net present value of the project is’ 0 ‘, which means that the discounted future cash inflows of the project are equal to the total cash outflows of that project.
Formula for Calculating Internal Rate of Return
In order to calculate IRR, consider the following formula:
- Internal Rate of Return
- Formula for Calculating Internal Rate of Return
- About the Calculator / Features
- How to Calculate using Calculator
- Example of Internal Rate of Return
- Interpretation of Internal Rate of Return
where a = lower rate of return
b = higher rate of return
NPVa =NPV at lower rate
& NPVb = NPV at higher rate.
About the Calculator / Features
IRR Calculator quickly delivers the result of the calculation by simply inserting the following details into it.
- Lower rate of return
- Higher rate of return
- The net present value at a lower rate
- The net present value at a higher rate
How to Calculate using Calculator
The user must provide the calculator with the following data to obtain immediate results.
Lower rate of return
The lower the rate of return, the higher the net present value.
Higher rate of return
Similarly, the higher the rate of return, the lower the net present value.
NPV at lower rate
It is the net present value calculated at the lower interest rate.
NPV at higher rate
It is the net present value that is calculated with a higher rate of return.
Example of Internal Rate of Return
Let us understand this concept using an example: Suppose you invested $10,000 for 3 years in Project X, and the money generated at the end of each year is $5,000. The discounting rates are 18% & 25%.
|Cash Inflows||Amount||PV @ 18%||PV @ 25%|
|At the end of 1st year||$5,000||$4,237||$4,000|
|At the end of 2nd year||$5,000||$3,591||$3,200|
|At the end of 3rd year||$5,000||$3,043||$2,560|
NPV @ 18% = 871 (i.e. 10,871 – 10,000)
& NPV @ 25% = -240 (i.e. 9,760 – 10,000)
Therefore IRR = 18% + [871/(871-(-240))](25% – 18%) = 23.49%
Interpretation of Internal Rate of Return
IRR gives us the rate at which the outflows of funds of a project are equal to the inflows of funds. It defines whether the project is advantageous or not. It implies that the IRR of the project is greater than the required rate of return. A higher IRR is usually preferred by companies, but a company can choose a lower IRR if it covers its cost of capital (k).
IRR is a very widely used concept, but sometimes its scope becomes limited. For example, when the discounting rate is unknown, one cannot find IRR. In such a scenario, the Net Present Value method comes into play. If the NPV of the project is greater than zero, the project stands feasible.