IRR Calculator

What this calculator tells you

The internal rate of return, or IRR, is the annual rate at which the money you put into an investment equals the present value of the money you get back. It summarises the return of a project or investment that has several cash flows, such as an initial cost followed by income over several years.

It is widely used to compare projects of different sizes and lengths, because it expresses each as a percentage a year. A higher IRR is generally better, but it should be read alongside the size of the investment and the risk involved.

How the IRR is found

The IRR is the rate that makes the net present value of all the cash flows equal to zero. Each payment in is treated as negative, each payment out as positive, and each is discounted by the rate for the number of years until it occurs. The equation has no simple closed form when there are several flows, so the calculator solves it numerically by trying rates until the value is close enough to zero.

A worked example

Suppose you pay 1,000 today and receive 1,100 in one year. The IRR is the rate that makes 1,100 divided by one plus the rate equal to 1,000, which gives a rate of exactly 10%. If instead you receive 1,210 after two years, the rate is again 10% a year, because 1,000 multiplied by 1.10 twice equals 1,210.

Warnings when reading the result

A project with several sign changes in its cash flows can have more than one IRR, or none, which makes the result hard to interpret. The IRR also assumes that money received can be reinvested at the same rate, which is often unrealistic for very high IRRs. For this reason, the IRR should be compared with other measures, such as the total cash returned and the net present value at a realistic discount rate.

Limits of the calculation

The IRR does not show the size of the return in money, so a small project with a high IRR can add less value than a large one with a lower IRR. Timing and the reliability of forecast cash flows matter a great deal, and the calculator takes the figures as given. Taxes, fees and risk premiums are not added separately, so enter the cash flows after costs and tax if you want an after-tax result.

Checking the cash flows

The quality of an IRR depends on the cash flows entered. Check the timing of each payment, whether costs such as maintenance and taxes are included, and whether the final value is a realistic sale price rather than an optimistic estimate. Test the result with lower income and a delayed sale to see how sensitive it is.

Where two projects are compared, check that they cover the same period and carry similar risk. An IRR can favour a short project even when a longer one would create more value overall.

Using the result

Use the IRR to compare investments with similar risk and timing, and to check whether a return is above the rate you could earn elsewhere. Pair it with the total money returned, and ask how sensitive the result is to the forecast, by testing lower cash flows.

Comparing projects of different lengths

When projects run for different lengths, the IRR alone can mislead, because a short project may show a high rate while adding less value overall. Look at the total cash returned and the net present value at a realistic discount rate alongside the IRR. If a longer project has a lower IRR but a much larger net present value, it may be the better use of the money.