Definition – What is Internal Rate of Return (IRR)?
Internal Rate of Return is a capital budgeting tool used to compare the different investments.
IRR takes a number of different projected cash flows and calculates the total return from them.
In this way, two equally sized investments can be compared from the standpoint of return on investment.
Internal Rate of Return Calculator
IRR Formula – How IRR is calculated
The IRR formula is very similar to Net Present Value. Net Present Value generates a value in today’s dollars, while IRR uses an initial investment to calculate the rate of return over the investment period.
IRR is calculated by using a process of trial and error. To find IRR, test different rates in a net present value calculation until net present value is equal to 0.
This calculator tests different rates of return and when NPV is equal to 0 it returns the rate that it found.
What is the difference between internal rate of return (IRR) and modified internal rate of return (mirr)?
MIRR is easier to calculate (IRR is only found through trial and error). MIRR also has other benefits such as factoring in the cost of capital.
IRR is difficult to calculate and can include situations where multiple rates of return can be generated. It also has a few drawbacks compared with other rate calculation methods.
Sources and External Resources
- Wikipedia – Internal Rate of Return – Wikipedia’s entry on internal rate of return, including its calculations and derivation.
- Math is Fun – Internal Rate of Return – Explanation of time value of money as well as internal rate of return.
- Carlos Magni – The Internal Rate of Return Approach and the AIRR Paradigm: A Refutation and a Corroboration – Details problems with using IRR when calculating rate of return.
- Carlos Magni – Average Internal Rate of Return and Investment Decisions: A New Perspective – Compares Average Internal Rate of Return with IRR.