Internal Rate of Return (IRR) is a discount rate that is used to identify potential/future investments that may be profitable. The IRR is used to make the net present value (NPV) of cash flows from a project/investment equal to zero.
Generally, the easiest way to calculate IRR is using an Excel spreadsheet. The download below allows you to work out the internal rate of return of a series of cash flows so that the NPV is discounted to $0.
Click here to download the IRR template
The IRR can be used for just about any potential investment, including the stock market, equipment, and other capital investments. While the projected amount of future cash flow is not always accurate due to a variety of factors, the IRR is a great jumping off point when considering any sort of future investment.
The IRR is also commonly used when comparing if it will be more profitable to open a new branch of business within a company or expand the operations of an existing one. An example of this would be a paper company deciding whether to open a new mill or simply expand an existing one. Both would certainly add value to the company, but the IRR could give a good indication of which is the more profitable decision in the long term.
For more analysis on internal rate of return and details on how the NPV formula is derived, please read our article on IRR article.
You can also use our free IRR calculator to calculate the IRR for up to 10 cash flows.
Frequently Asked Questions
What is the internal rate of return (IRR)?
The internal rate of return (IRR) is a discount rate that is used to identify potential/future investments that may be profitable. The IRR is used to make the NPV of cash flows from a project/investment equal to zero.
How do I calculate the internal rate of return IRR in Excel?
IRR is calculated by using the Excel IRR function. The function takes in a series of cash flows and calculates the rate that makes the NPV of those cash flows equal to zero.
What are some common uses for the internal rate of return (IRR)?
The internal rate of return is most commonly used when evaluating potential investments. It can be used to compare the profitability of different investments, as well as whether it is more advantageous to open a new business or expand an existing one. In addition, the IRR can be helpful in budgeting and forecasting future cash flows.
What is a good IRR return?
Analysts generally consider an IRR of approximately 22% or greater to be a good return. Conversely, anything below 10% is generally seen as not being worth pursuing. However, it is important to remember that the IRR is just one factor to consider when making an investment decision and should not be the only thing looked at.
How do you increase IRR?
There are a few things that can be done to increase the IRR on an investment. One is to make sure that the cash flows are evenly distributed over time. Another is to try and reduce the amount of non-cash expenses associated with the investment. Finally, it is important to ensure that there is a good potential for capital gains on the investment.