This IRR calculator can approximate the internal rate of return an investment can ensure by considering its initial cost and the generated ins and outs cash flows. There is in depth information on how to determine this rate of return below the form.
How does this IRR calculator work?
The financial application can help when trying to determine the internal rate of return of an investment by taking account of its initial cost of implementation and the cash flows it generates year by year. Please note that the tool is very flexible as it allows users to add as many ins and outs cash flows as they want by simply pressing “+1 YEAR” button.
The algorithm behind this IRR calculator uses the net present value (NPV) formula which is a function of the rate of return. Practically the tool finds the right value of the rate of return (IRR) for which the NPV function is zero as explained here:
N = total number of periods/years;
r = internal rate of return;
Cn = the cash flows pairs per each year (n).
In finance, IRR is the acronym for internal rate of return which defines the relative return an investor can get from an investment plan used to measure and compare the profitability of investments.
It is often referred to as the economic rate of return (ERR), as the effective interest rate or as the discounted cash flow rate of return (DCFROR).
As it can observed from its equation the internal rate of return is the return percentage that makes the net present value of all generated cash flow (positive and negative) equal to zero.
More specifically IRR is used to evaluate the attractiveness of an investment project, thus the higher its value is the better.
The usability of the IRR
Basically the internal rate of return is an efficiency indicator thus it is often used to asses and decide whether its level is at least equal or greater than a minimum acceptable rate of return an investor is searching for.
Example of a calculation
Let’s assume an investment project with these characteristics and figure out its IRR level:
- Initial cost of $1,000,000 that is expected to generate the cash flows presented below;
- Year 1: Cash IN = $100,000; Cash OUT = $10,000;
- Year 2: Cash IN = $100,000; Cash OUT = $15,000;
- Year 3: Cash IN = $150,000; Cash OUT = $19,000;
- Year 4: Cash IN = $160,000; Cash OUT = $25,000;
- Year 5: Cash IN = $200,000; Cash OUT = $30,000;
- Year 6: Cash IN = $200,000; Cash OUT = $50,000;
- Year 7: Cash IN = $250,000; Cash OUT = $35,000;
- Year 8: Cash IN = $250,000; Cash OUT = $55,000;
- Year 9: Cash IN = $300,000; Cash OUT = $60,000;
- Year 10: Cash IN = $200,000; Cash OUT = $15,000.
What will be the internal rate of return?
■ Internal Rate of Return (IRR) = 8.12%
■ Total Cash In = $1,910,000.00
■ Total Cash Out = $1,314,000.00
■ Net Cash Flow = $596,000.00
|Year||Cash In ($)||Cash Out ($)||Net Cash Flow ($)|