IRR — Internal Rate of Return Formula
IRR is the discount rate that makes the Net Present Value (NPV) of all cash flows equal to zero. It represents the project's actual rate of return.
Internal Rate of Return Formula
0 = Sum of [CFt / (1 + IRR)^t] for t = 0 to n
Where:
- CFt = Cash flow at time t
- IRR = Internal Rate of Return (what we solve for)
- t = Time period
- n = Total number of periods
Step-by-Step:
- 1
List all cash flows
Include initial investment (negative) and all future returns (positive).
- 2
Set NPV = 0
The IRR is the rate r where NPV equals zero.
- 3
Solve iteratively
Use trial-and-error, Excel's =IRR(), or a financial calculator.
Worked Examples:
Project evaluation
Year 0: -₹10LYear 1: ₹3LYear 2: ₹4LYear 3: ₹5L
Result: IRR = 8.9%
At 8.9% discount rate, NPV = 0. If your required return is <8.9%, accept the project.