Free Online IRR Calculator – Instantly Calculate Internal Rate of Return
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What is IRR
Today, let's dive into an important financial concept: the Internal Rate of Return (IRR).
In our previous post, we explored Net Present Value (NPV) — a useful tool for evaluating whether an investment, project, or business opportunity is worth pursuing. NPV helps you make informed financial decisions by comparing the value of future cash flows to your initial investment.
Just like NPV, IRR is another powerful method used to assess the profitability of an investment.
Let’s break it down with an example. Suppose you invest $1 million in a car rental business. Over the next five years, you earn different amounts — maybe $150,000 in one year, $250,000 in another. At the end of the fifth year, you sell the car fleet and receive additional cash. Now, you may wonder: What’s my annual return on this investment? That’s exactly what IRR helps you figure out.
Here’s another scenario: say you’re investing in a Fixed Deposit (FD) where interest rates vary month to month — just like many real bank products. If your income from the FD isn’t consistent each year, IRR helps you determine the effective average annual return you’re earning.
In this post, we’ll explore:
• What IRR is
• How it’s calculated
• Why it’s useful for making investment decisions
Let’s get started!
What is the Internal Rate of Return (IRR)?
Imagine a company considering a new investment project. They've already invested $1 million and now want to know what kind of return they can expect on that money. Specifically, they’re looking to calculate the annual percentage returns—this helps them decide whether the investment is worth pursuing.
In our previous post, we discussed Net Present Value (NPV), which tells us whether a project is financially viable. Now, we're shifting our focus to another key metric: Internal Rate of Return (IRR).
IRR represents the annualized rate of return a project is expected to generate. In technical terms, it's the discount rate at which the NPV of all future cash flows equals zero. In simpler words, it tells us how fast our investment will pay off, or what percentage return we can expect each year.
Understanding IRR helps businesses make smarter investment decisions by evaluating how profitable a project, business, or financial product really is.
A Simple IRR Calculation Example
Imagine you invest $10,000 today, and a year later, you receive $12,000 from that investment. To evaluate the profitability of this investment, we need to calculate the Internal Rate of Return (IRR). But how do we do that?
First, let's recall the formula for Net Present Value (NPV):
NPV = FV / (1 + r)ⁿ
Where:
• FV is the future value
• r is the rate of return (or IRR, in this case)
• n is the number of periods (years)
Applying this to our example:
NPV = -$10,000 / (1 + r)⁰ + $12,000 / (1 + r)¹
We use -10,000 because it's an outflow — the amount you invest at time zero. Then, you receive $12,000 at the end of year one, which is an inflow.
Now, by definition, IRR is the rate at which the NPV becomes zero. So we set the NPV equation to zero:
0 = -10,000 + 12,000 / (1 + r)
Let's solve it step by step:
10,000 = 12,000 / (1 + r)
1 + r = 12,000 / 10,000 = 1.2
r = 1.2 - 1 = 0.2
Convert the decimal to a percentage:
IRR = 0.2 × 100% = 20%
So, the internal rate of return for this investment is 20% — meaning you're earning a 20% return on your initial $10,000 investment over one year.
About the Author: Abhishek Lohar
B.Com Graduate and the Founder of Free Online Financial Calculator. I specialize in simplifying complex financial calculations and investment strategies. My mission is to ensure you can make confident financial decisions using our research-backed content and accurate calculators.
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Disclaimer: The information provided in this article is for educational purposes only and should not be considered financial advice. Please consult with a qualified professional before making any investment decisions.