Internal Rate of Return
How to Calculate IRR
The internal rate of return (or IRR) is the rate that sets the net present value (NPV) of a stream of cash flows for a project to $0.[1]
NPV is a tool used in corporate finance to estimate future returns on an investment in dollars. We cover NPV in more detail below, and you can also learn more about it on our NPV calculator.
The higher the IRR, the more financially successful a project is. A project’s IRR needs to be higher than the company’s required rate of return in order for the company to move forward with a project.[2]
The minimum required rate of return, sometimes referred to as the hurdle rate, is usually set at the weighted-average cost of capital (WACC) for the investment.
The IRR is essentially the compounded annual growth rate that a project is expected to earn. If a project has an initial investment of $1,000 and earns a 15% internal rate of return for five years, it is equivalent to earning 15% over five years.
While this 15% is not earned consistently each year, the IRR smooths out the return over the lifetime of the project. Try our ROI calculator to see what the compounded annual growth rate is on an investment.
The IRR assumes that each cash flow is received/paid at the end of the year. This is not a likely assumption but allows for simplicity in the calculation.
IRR Calculator
