IRR Calculator

What is IRR?

In technical terms, IRR can be defined as the particular rate at which the Net Present Value (NPV) of your future cash flow stream becomes exactly equal to zero.

It's particularly useful when it comes to comparing two or more potential investments and where it helps you evaluate which one might be the better choice. Let's start with an example: if you put $10,000 into project A, which returns $4,000 a year for 3 years, and compare it to project B, which returns $6,000, $3,000 and $3,000 over those same years, the one with the higher IRR is your best option.

It's important to understand that IRR as an indicator of return is only one of a number of decision-making criteria in evaluating investments, and the information in this article, and that of the calculator, is not to be used as financial advice. You should always seek professional advice when comparing investments.

Calculating IRR is quite a technically complex operation however. Fortunately our IRR tool does all the work for you. Just enter your initial investment and each year's expected cash flows, and the calculator will return the IRR for you. It even works for uneven cash flows — the reason that this calculator may be more useful than a simple CAGR tool.

It takes 1 steps: input IRR a couple of inputs for calculator. And you've the IRR. But let's go into the details below.

How to calculate IRR

When calculating IRR, you'd normally use something called the NPV (Net Present Value) — actually, that's the base for IRR. To find your value (NPV), the standard formula is:

Please note, as finding a direct algebraic solution is not possible for more than a few periods, we use the Newton-Raphson method, which is an iterative approximation process. Our calculator handles all of this automatically for you.

Once you've entered your investments, you've entered both your initial outlay, as well as the return or the income. If your results return a value that is higher in the return value, this is positive, meaning the IRR of your investment is delivering. On the other hand, in some cases in the future a reduction in cash or cash equivalents and a loss occurs.

The entire math is quite complicated even today, particularly for uneven cash flow patterns. See our explanation of how compound interest works for further context on time value of money.

What is the net present value?

Net present value (NPV) measures the current total value of future cash flows, discounted back to the current date using a specific rate: normally, a cost of capital. Essentially, what is a dollar received in the future worth today?

NPV formula

Simple IRR calculator example

Let's assume you make an initial investment of $10,000 and gain cash returns of $4,000, $4,000 and $4,000 in years 1, 2 and 3 respectively.

We input the values of our three yearly periods with the expected returns into our basic IRR calculator. The cash inflows of the three years were the subsidiary effect of our calculation function.

We convert these into P, C₁, C₂, C₃:

IRR example with irregular cash flows

Of course, real-life investments deliver very irregular and non-equal cash flows in the real world. And this is where the IRR calculator truly shines: it handles any series of cash flows with ease.

Let's give an extra cash flow from your real estate business. Let's say you invest $150,000 in a rental building in Year 0. You expect the following cash flows from it over the next five years:

• Year 1: $25,000
• Year 2: $35,000
• Year 3: $40,000
• Year 4: $45,000
• Year 5: $50,000 (including sale of property and final income) ($120,000 if property sold)

When we plug those irregular cash flows into our calculator, the result is a roughly 15-20% annual rate, depending on the final figure used. Of course, the calculator does the heavy-lifting of the computation.

The example shows that IRR is a powerful tool as well as an important and comparative metric — so just by comparing your return on investment to an alternative: let's say you had put that same $150,000 into stocks or bonds. Is your real estate investment providing a better internal rate of return? That's precisely what this comparison allows you to evaluate.

What is the difference between IRR and NPV?

While both IRR and NPV are commonly used to evaluate the viability of investments, they work in somewhat different ways. While the IRR indicates the annualized rate of return, the NPV shows a total return, but in dollar terms, showing the profit in today's terms. Both are incredibly useful, but for different purposes.

Choosing between the two? For comparing projects of similar size and scope, use IRR. If the IRR exceeds your cost of capital, it's a profitable investment. For a comparison in actual dollar terms of profit, NPV is the better metric: a higher NPV means a higher total return, measured in today's money. In practice, investors and analysts often use both to get a complete picture.

IRR, NPV and CAGR

The difference between IRR and CAGR is important. While they are very similar in looking at the rate of return on your investment, one provides a more nuanced picture than the other. These related measures each fill a slightly different role in an investor's toolkit.

CAGR is a measurement of the rate at which your value has moved from a starting value to an ending value. CAGR is simpler to compute since CAGR only requires your starting and ending values, and the length of the investment in years. It assumes a smooth compound growth trajectory, regardless of what actually happened year to year.

By contrast, typically a profit or growth rate is described in a profile for a particular situation: your own year after year returns. It is valuable to have data that allows you to compare actual projections: IRR on the other hand accepts each individual cash flow, including the timing of those cash flows, and factors them into its rate calculation.

I agree, say Topic 8, 179 industries can affect each one positively and some may or are not used. Further at a number level, the differences compare a return on three values versus many: meaning it is applicable in more varied investment types.

Why do I need both to know what the return on a portfolio is or from an investment?