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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.

FAQs

1. 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.

2. How do you calculate the Internal Rate of Return (IRR)?

The IRR is calculated by plugging in all the cash flows for an investment into a formula. This will give you a decimal number. If this decimal number is greater than the cost of capital, then this is your Internal Rate of Return.

3. What is a good Internal Rate of Return (IRR)?

A good Internal Rate of Return is entirely subjective. It depends on what you're comparing your investment to (other investments, the value of the investment at that time, inflation rates, etc.).

4. Is a higher Internal Rate of Return (IRR) better?

Higher IRR can mean that the investment is more profitable. However, it also means that the investment takes longer to pay back.

5. How do you convert cash to an Internal Rate of Return (IRR)?

Cash to IRR is calculated by taking the cash flow and multiplying it by (1+IRR). The result of this should be the future value.

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