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.
IRR is primarily calculated by using a combination of trial and error and financial time value calculations (primarily net present value) to find the overall rate of return for a series of cash flows.
For IRR, the net present value of the cash flows is calculated with a guessed rate of return. If the guessed rate does not match, then a new guessed rate is used to calculate the NPV, and so on until a matching rate of return is found.
What is Present Value?Present Value (PV) is the total value at the beginning of the time period.
What is Future Value?Future Value (FV) is the total value at the end of the time period.
What are periods?Periods are the number of times that compounding (and payments) take place.
What is the rate?The rate is the amount of interest earned per compounding period.
What is Payment (PMT)?A payment is an amount either deposited or withdrawn at each compounding period. A negative number designates an amount that is deposited, while a positive one withdrawn. For example, if $100 is deposited each compounding period, it would be entered as '-100', while if $75 was payed out each compounding period, it would be entered as '75'.
What is Payments at start or end of a period?A payment at the beginning of a period would mean that the payment (or deposit) occurs at the beginning of each period. A payment at the end of a period would mean that the payment (or deposit) occurs at the end of each period.
- Wikipedia – Time Value of Money
- Wikipedia – Internal Rate of Return
- Math is Fun – Internal Rate of Return