How to Use Our IRR Calculator

Our calculator is designed to be straightforward. You’ll need to list all the cash flows associated with your investment, from the very beginning to the end.

• Initial Investment ($): This is your first cash flow and is almost always a negative number. Enter the full amount you invested upfront (e.g., -100000 for a $100,000 investment).

• Cash Flows (per period): Enter the series of cash flows you received or paid out for each period (typically each year).

  • Positive Numbers: Use for cash you receive (e.g., rental income, revenue).

  • Negative Numbers: Use for cash you pay out (e.g., additional investments, major repairs).

The calculator will let you add as many cash flow periods as you need for your project’s timeline.

Understanding Your Results

The calculator’s result is the Internal Rate of Return (IRR), shown as an annual percentage.

In simple terms, the IRR is the breakeven interest rate for your investment. It’s the specific discount rate at which the Net Present Value (NPV) of all your cash flows (both incoming and outgoing) equals zero.

Here’s the practical way to use it:

• If your IRR is higher than your cost of capital (the interest rate you pay on loans or the return you could get from a safer investment), your project is considered profitable.

• If your IRR is lower than your cost of capital, the project is not financially viable.

Example Breakdown

Let’s say you invest in a project with the following cash flows: | Period | Cash Flow | Description | | :— | :— | :— | | Year 0 | -$50,000 | Initial Investment (e.g., buying equipment) | | Year 1 | +$15,000 | Net income from the first year | | Year 2 | +$20,000 | Net income from the second year | | Year 3 | +$25,000 | Net income from the third year |

For this series of cash flows, the IRR would be 14.3%. If you could borrow money at 8% to fund this project, it would be a good investment because 14.3% is greater than your 8% cost.

Frequently Asked Questions

What’s the difference between IRR and ROI?

Return on Investment (ROI) is a simple metric that calculates the total profit as a percentage of the total cost. It’s useful for a quick snapshot but has major drawbacks: it doesn’t consider the time value of money or how long it took to generate the return.

Internal Rate of Return (IRR) is a much more sophisticated metric. It provides an annualized rate of return and inherently accounts for when you receive cash flows, making it a superior tool for comparing projects with different timelines and cash flow patterns.

What is a “good” IRR?

A “good” IRR is always relative to your other options. There are two main benchmarks to compare it against:

1. Cost of Capital: Your IRR should always be higher than the interest rate you pay on any funds borrowed to finance the project.

2. Opportunity Cost: Your IRR should be higher than the return you could get from an alternative investment with similar risk, like an S&P 500 index fund (which has a historical average of ~10%). If your project’s IRR is 12%, but you could get 10% from a passive index fund, that 2% difference is your premium for the extra work and risk.

What is Net Present Value (NPV) and how does it relate to IRR?

Net Present Value (NPV) calculates the value of all future cash flows in today’s dollars. It tells you the total amount of profit a project will generate, in absolute dollar terms.

IRR and NPV are directly related and form a key rule in finance:

• IRR is the discount rate that makes NPV equal to $0.

• If you use a discount rate that is lower than the IRR, the NPV will be positive (a profitable project).

• If you use a discount rate that is higher than the IRR, the NPV will be negative (an unprofitable project).

When should I use an IRR calculator?

You should use an IRR calculator whenever an investment involves multiple cash flows over multiple periods. It is the standard for analyzing projects like:

• Buying and managing a rental property (initial purchase, annual income, final sale).

• Evaluating a business venture or equipment purchase.

• Complex financial instruments with periodic payouts.

For a simple, one-time investment that you buy and hold, an [Average Return Calculator (CAGR)] is more appropriate.

What are the limitations of IRR?

While powerful, IRR has two main limitations to be aware of:

1. Multiple IRRs: If your cash flows switch from negative to positive more than once (e.g., -100, +200, -50), it’s possible to get multiple valid IRR results, which can be confusing.

2. Reinvestment Assumption: IRR assumes that all positive cash flows are reinvested and earn a return equal to the IRR itself. This may not be realistic, as you might reinvest the money in a project with a lower return.

Analyze Your Investments Further

• After finding your IRR, calculate the absolute profit in today’s dollars with our Net Present Value (NPV) Calculator.

• For a simpler look at investment viability, find out how long it will take to recoup your initial cost with our Payback Period Calculator.