What is IRR?
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 plain English: it's the annualized return your investment is expected to generate, accounting for the timing of every cash flow in and out.
IRR is widely used in private equity, real estate, and capital budgeting to compare projects of different sizes and timelines. If the IRR exceeds your required rate of return (also called the hurdle rate), the investment is generally worth pursuing.
How is IRR calculated?
IRR is the rate r that satisfies this equation, where CF₀ is the initial investment (negative) and CF₁, CF₂ … CFₙ are future cash flows:
0 = CF₀ + CF₁(1+r) + CF₂(1+r)² + … + CFₙ(1+r)ⁿ
There's no closed-form algebraic solution — IRR is found iteratively. This calculator uses Newton-Raphson iteration, the same method used by Excel's IRR function, converging to a precise answer in milliseconds.
Worked example: You invest $10,000 today and receive $4,000 in Year 1, $4,000 in Year 2, and $5,000 in Year 3. Enter −10000, 4000, 4000, 5000. The IRR is approximately 21.6% — meaning this investment returns 21.6% per year on your capital, accounting for the timing of each cash flow.
When to use IRR
IRR is most useful when you need a single percentage figure to compare against a benchmark. Common use cases:
- Hurdle rate comparison: A private equity fund with a 15% hurdle rate will only invest in deals with an expected IRR above 15%.
- Real estate underwriting: Investors use IRR to compare a value-add apartment deal against a net-lease property with different cash flow profiles.
- Capital budgeting: A company choosing between two factory upgrades with different upfront costs and payback timelines uses IRR to rank them on a common scale.
When comparing mutually exclusive projects (you can only pick one), prefer NPV — it measures absolute value created in dollars. IRR tells you the rate of return but not the magnitude.
Common mistakes
- Forgetting the initial investment: Year 0 must be negative (cash out). If you enter all positive numbers, the calculation has no solution.
- Multiple IRRs: If your cash flows change sign more than once (e.g., negative, positive, negative again), there can be multiple mathematically valid IRRs. The result is ambiguous — use the NPV calculator instead.
- Ignoring project scale: A 50% IRR on a $1,000 investment creates $500 of value. A 20% IRR on a $1,000,000 investment creates $200,000. IRR alone doesn't tell you which is better — that's what NPV is for.
- The reinvestment assumption: IRR implicitly assumes interim cash flows are reinvested at the IRR itself. For high-IRR projects this is often unrealistic. Modified IRR (MIRR) lets you specify a separate reinvestment rate.
How to use this calculator
Enter your initial investment as a negative cash flow (Year 0), then add positive cash flows for each subsequent year. You can add as many years as needed using the + button or Ctrl+Enter.
Frequently Asked Questions
What is a good IRR?
A "good" IRR depends on the asset class and risk profile. For private equity, a 20%+ IRR is typically expected. For real estate, 12–18% is common for value-add deals. For public equities, anything above the S&P 500's historical ~10% is outperformance. Always compare against your hurdle rate — the minimum return you require for a given level of risk.
What is the difference between IRR and NPV?
IRR is a percentage return; NPV is a dollar amount. NPV tells you how much value an investment adds in today's dollars given a specific discount rate. IRR tells you the rate at which NPV equals zero. For ranking independent projects, NPV is generally more reliable — IRR can give misleading results when cash flows change sign multiple times.
What does a negative IRR mean?
A negative IRR means the investment is expected to lose money — you get back less in total than you put in, even before adjusting for time. It's a clear signal to pass unless there are non-financial reasons to proceed.
What are the limitations of IRR?
IRR assumes that interim cash flows are reinvested at the same IRR — which is often unrealistic for high-return projects. It can also produce multiple solutions when cash flows change sign more than once. Modified IRR (MIRR) addresses the reinvestment assumption, and NPV is generally preferred for absolute value comparisons.