IRR

What is IRR? IRR is the internal rate of return for investment. The internal rate of return is a metric used in financial analysis to estimate the profitability of potential investments. The internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis. IRR calculations rely on the same formula as NPV does.

KEY TAKEAWAYS

• IRR is the annual rate of growth an investment is expected to generate.
• IRR is calculated using the same concept as NPV, except it sets the NPV equal to zero.
• IRR is ideal for analyzing capital budgeting projects to understand and compare potential rates of annual return over time.

To calculate IRR using the formula, one would set NPV equal to zero and solve for the discount rate, which is the IRR. However, because of the nature of the formula, IRR must be calculated iteratively or using software programs. Excel and Googlesheets have built-in functions for calculating IRR and XIRR.