IRR (Internal Rate of Return) is the discount rate that makes the Net Present Value (NPV) of all cash flows equal to zero. It represents the expected annualized rate of return an investment will generate over its lifetime.

How do you calculate IRR?

IRR is calculated by finding the rate (r) where NPV = 0. The formula is: ∑(CFt / (1+r)^t) = 0. Since there's no closed-form solution, IRR is found through iteration using methods like Newton-Raphson or Excel's IRR function.

A good IRR depends on context. Generally, an investment is attractive if IRR exceeds the cost of capital (WACC). Private equity targets 20-25%+, venture capital seeks 30%+ for early-stage, and real estate targets 15-20%. Always compare against your hurdle rate.

What's the difference between IRR and NPV?

NPV tells you the dollar value created at a given discount rate, while IRR tells you the break-even rate of return. NPV is better for ranking projects (choose higher NPV), while IRR is useful for comparing against a hurdle rate. Use both together for comprehensive analysis.

What is IRR (Internal Rate of Return)?

IRR is the discount rate that makes the Net Present Value (NPV) of all cash flows equal to zero. It represents the expected annualized rate of return an investment will generate. IRR is widely used in capital budgeting to evaluate the attractiveness of investments and compare projects of different sizes and durations.

How do you calculate IRR?

IRR is calculated by finding the rate (r) where NPV = 0: ∑(CFt / (1+r)^t) = 0, where CFt is the cash flow at time t. Since there's no closed-form solution, IRR is found through iteration (trial and error, Newton-Raphson, or using Excel's IRR function). The initial investment is typically negative, and subsequent cash flows are positive.

A 'good' IRR depends on context and risk. Generally, an investment is attractive if IRR exceeds the cost of capital (WACC). Private equity firms often target 20-25%+ IRR. Venture capital may seek 30%+ for early-stage investments. Real estate might target 15-20%. Always compare IRR against your required rate of return or hurdle rate.

What's the difference between IRR and NPV?

NPV tells you the dollar value created by an investment at a given discount rate, while IRR tells you the break-even rate of return. NPV is better for ranking projects (choose higher NPV), while IRR is useful for comparing against a hurdle rate. IRR can give misleading results with unconventional cash flows (multiple sign changes).

When should I use IRR vs NPV?

Use NPV when ranking mutually exclusive projects of different sizes, as it shows absolute value creation. Use IRR when comparing against a hurdle rate or when communicating returns to stakeholders. NPV is generally preferred in academic finance, but IRR remains popular in practice because it's expressed as a percentage that's easy to understand.

What are the limitations of IRR?

IRR has several limitations: (1) Multiple IRRs can exist when cash flows change signs more than once, (2) IRR assumes reinvestment at the IRR rate, which may be unrealistic, (3) It can't handle mutually exclusive projects of different scales, (4) It doesn't account for project risk. Consider using Modified IRR (MIRR) to address reinvestment assumptions.

How do I calculate IRR in Excel?

Excel offers two IRR functions: IRR(values, [guess]) for regular periods and XIRR(values, dates, [guess]) for irregular timing. For example, =IRR(A1:A5) calculates IRR for cash flows in cells A1 to A5. The guess parameter (optional) helps Excel converge when there are multiple possible solutions.

What is MIRR (Modified Internal Rate of Return)?

MIRR addresses IRR's reinvestment assumption by using separate rates for financing costs and reinvestment returns. MIRR formula uses your cost of capital for negative cash flows and a reinvestment rate (often WACC) for positive cash flows. This provides a more realistic return estimate and always produces a single value, unlike IRR.

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Initial Investment (Year 0)

This is the upfront cost (treated as a negative cash flow)

Future Cash Flows

Year 1

Year 2

Year 3

Hurdle Rate (Optional)

Compare IRR against your minimum required return (%)

IRR Definition: Rate where NPV = ∑(CFt / (1+r)^t) = 0

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What is IRR?

IRR (Internal Rate of Return) is the discount rate that makes the Net Present Value (NPV) of an investment equal to zero. It represents the expected compound annual rate of return that the investment will generate over its lifetime.

IRR is widely used in finance because it:

Expresses returns as a single percentage that's easy to understand and compare
Accounts for the time value of money across all cash flows
Enables comparison against hurdle rates and cost of capital (WACC)
Works for investments with irregular cash flow patterns

Example IRR Calculation

An investment of $100,000 generates cash flows of $40,000, $45,000, and $50,000 over 3 years:

Year 0: -$100,000 (initial investment)

Year 1: +$40,000

Year 2: +$45,000

Year 3: +$50,000

Find r where: -100,000 + 40,000/(1+r) + 45,000/(1+r)² + 50,000/(1+r)³ = 0

IRR ≈ 17.1%

If the company's WACC is 10%, this investment creates value because IRR (17.1%) exceeds the cost of capital.

IRR vs NPV: When to Use Each

Both metrics measure investment attractiveness, but serve different purposes

Use IRR When...

• Comparing against a hurdle rate or WACC
• Communicating returns to stakeholders who prefer percentages
• Evaluating single projects on a go/no-go basis
• Cash flows are conventional (one sign change)

Use NPV When...

• Ranking mutually exclusive projects of different sizes
• You need to know absolute dollar value created
• Cash flows have multiple sign changes
• Making capital allocation decisions across projects

The Decision Rule

Accept a project if IRR > WACC (or your hurdle rate). This is equivalent to NPV > 0. When ranking multiple projects, always use NPV because a 100% IRR on a $1,000 project creates less value than 20% IRR on a $1,000,000 project.

When to Use IRR

IRR is fundamental to investment analysis across industries

Private Equity & VC

IRR is the primary performance metric for funds. LPs evaluate GPs based on net IRR, and deal teams calculate projected IRR for each investment opportunity.

Capital Budgeting

Companies use IRR to evaluate capital projects like equipment purchases, facility expansions, and R&D investments against their cost of capital.

Real Estate Development

Property developers calculate levered and unlevered IRR to evaluate deals, structure financing, and compare opportunities across different markets and asset classes.

M&A Analysis

Acquirers calculate IRR of potential acquisitions based on projected synergies and exit assumptions. IRR helps determine maximum bid prices and deal structures.

How to Calculate IRR in Excel

Excel provides built-in functions for IRR calculation. Here are the most common methods:

Method 1: IRR Function (Regular Periods)

Use when cash flows occur at regular intervals (monthly, annually):

=IRR(values, [guess])

Example: =IRR(A1:A5) where A1 = -100000, A2:A5 contain positive cash flows

Method 2: XIRR Function (Irregular Periods)

Use when cash flows occur on specific dates (more realistic for most investments):

=XIRR(values, dates, [guess])

Example: =XIRR(B1:B5, A1:A5) where column A has dates and column B has cash flows

Method 3: MIRR Function (Modified IRR)

Addresses reinvestment rate assumption by using separate finance and reinvestment rates:

=MIRR(values, finance_rate, reinvest_rate)

Example: =MIRR(A1:A5, 0.10, 0.08) with 10% borrowing cost and 8% reinvestment rate

Pro Tip: Convergence Issues

If IRR returns an error, try providing a guess parameter (e.g., 0.1 for 10%). This helps Excel converge when there are multiple possible IRRs or the solution is far from the default guess.

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Frequently Asked Questions

Everything you need to know about IRR calculations

Related resources

NPV Calculator WACC Calculator CAGR Calculator ROI Calculator Consulting Charts

IRR Calculator

Now visualize it in PowerPoint

What is IRR?

Example IRR Calculation

IRR vs NPV: When to Use Each

Use IRR When...

Use NPV When...

The Decision Rule

When to Use IRR

Private Equity & VC

Capital Budgeting

Real Estate Development

M&A Analysis

How to Calculate IRR in Excel

Method 1: IRR Function (Regular Periods)

Method 2: XIRR Function (Irregular Periods)

Method 3: MIRR Function (Modified IRR)

Pro Tip: Convergence Issues

Related Resources

NPV Calculator

WACC Calculator

ROI Calculator

Financial Charts

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Frequently Asked Questions

What is IRR (Internal Rate of Return)?

How do you calculate IRR?

What is a good IRR?

What's the difference between IRR and NPV?

When should I use IRR vs NPV?