Internal Rate of Return (IRR) Calculator
Calculate the discount rate that makes NPV equal to zero for your investment
IRR Concept
What is Internal Rate of Return?
The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows from an investment equal to zero. In simpler terms, it's the expected compound annual rate of return that an investment will generate. IRR is widely used in capital budgeting to compare and evaluate investment opportunities.
When evaluating a project, you compare the IRR to your required rate of return (hurdle rate). If the IRR exceeds your hurdle rate, the investment is considered acceptable. The higher the IRR above your hurdle rate, the more attractive the investment becomes.
IRR is particularly useful because it provides a single percentage that can be easily compared across different investments, regardless of their size. However, it has limitations that investors should understand, particularly regarding reinvestment assumptions and multiple IRR problems.
IRR vs Other Return Metrics
IRR
The rate where NPV = 0. Shows effective annual return considering time value of money.
NPV
Dollar value created. Better for comparing mutually exclusive projects of different sizes.
ROI
Simple percentage return ignoring timing. (Gain - Cost) / Cost. Quick but less accurate.
Payback Period
Time to recover investment. Ignores time value of money and cash flows after payback.
IRR Benchmarks by Investment Type
Acceptable IRRs vary significantly by investment type, risk level, and market conditions.
| Investment Type | Typical IRR Range | Risk Level | Notes |
|---|---|---|---|
| Treasury Bonds | 3-5% | Very Low | Risk-free baseline |
| Corporate Bonds | 5-8% | Low | Credit risk premium |
| Stock Market (Index) | 8-12% | Medium | Long-term average |
| Real Estate | 10-20% | Medium-High | Location dependent |
| Private Equity | 15-25% | High | Illiquidity premium |
| Venture Capital | 25-40% | Very High | Most investments fail |
| Startup Investment | 30-50%+ | Extreme | Power law returns |
Limitations of IRR
Reinvestment Assumption
IRR assumes intermediate cash flows can be reinvested at the IRR itself. This is often unrealistic for very high IRRs. Modified IRR (MIRR) addresses this issue.
Multiple IRRs
Projects with alternating positive and negative cash flows can have multiple IRRs or no real IRR at all. Use NPV analysis instead for such projects.
Scale Ignorance
IRR doesn't account for project size. A 50% return on $1,000 creates less value than 20% on $1 million. Always consider NPV alongside IRR.
Timing Bias
IRR favors projects with quick returns even if slower projects create more total value. Consider both IRR and NPV in your analysis.
Frequently Asked Questions
What's a good IRR for an investment?
It depends on the investment's risk. At minimum, IRR should exceed your cost of capital. For equity investments, target at least 10-15%. Higher-risk ventures like startups typically require 25%+ to compensate for failure risk.
Can IRR be negative?
Yes. Negative IRR means the investment loses money. You'd need to add money rather than receive returns to make NPV equal zero. This clearly indicates a bad investment.
Should I choose the project with the highest IRR?
Not necessarily. For mutually exclusive projects, NPV is the better criterion. A larger project with lower IRR might create more total value. IRR is best for yes/no decisions on independent projects.
What's the difference between IRR and CAGR?
CAGR (Compound Annual Growth Rate) is a simpler calculation that only considers start and end values. IRR considers all intermediate cash flows and their timing, making it more comprehensive for complex investment analysis.
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