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IRR

Investment

Internal Rate of Return

The discount rate at which the net present value of all cash flows from an investment equals zero — effectively the annualised rate of return expected from the project.

Definition

Internal Rate of Return (IRR) is the discount rate at which the Net Present Value (NPV) of all cash flows from an investment equals zero. In simpler terms, it is the annualised rate of return that an investment is expected to generate, expressed as a percentage.

IRR is widely used to compare investment opportunities, evaluate capital budgeting decisions, and assess the viability of projects. If the IRR of a project exceeds the investor's required rate of return (hurdle rate), the project is considered worthwhile.

IRR assumes that all cash flows are reinvested at the same rate as the IRR itself — an optimistic assumption that can overstate returns in practice.

Formula

IRR is the rate r that solves:

∑ [Cₜ / (1+r)^t] = 0 for t = 0, 1, 2, … n

Where:

  • C₀ = Initial investment (negative cash flow)
  • Cₜ = Cash flow at time t (positive for inflows)
  • r = IRR (the rate being solved for)

This equation has no closed-form solution and is solved iteratively. Financial calculators and spreadsheet functions (=IRR in Excel) use Newton-Raphson or trial-and-error methods.

Worked Example

You invest ₹10,00,000 in a real estate property at Year 0 and receive:

  • Year 1: ₹80,000 (rental income)
  • Year 2: ₹85,000
  • Year 3: ₹90,000
  • Year 3 end: ₹13,00,000 (sale proceeds)

Cash flows: −10,00,000 | +80,000 | +85,000 | +13,90,000

Solving for r using trial-and-error (or Excel's =IRR):

IRR ≈ 13.8% per annum

This means the investment equivalent to putting money in an instrument earning 13.8% per annum. Use the XIRR calculator for similar real-world scenarios with irregular cash flow dates.

Key Things to Know

  • IRR vs CAGR: CAGR works only for single investments growing to a single value. IRR handles multiple interim cash flows (rents, dividends, premiums). Use CAGR for simple investments; use IRR or XIRR for anything more complex.
  • Hurdle rate: Always compare IRR to your hurdle rate (required rate of return or cost of capital). If IRR > hurdle rate → invest. If IRR < hurdle rate → reject.
  • EMI and IRR: The effective interest rate on a loan (after accounting for processing fees and other costs) is essentially the IRR of the loan cash flows. This is why APR is often close to the IRR of a loan.
  • Real estate: IRR is the standard metric for evaluating real estate deals in India, accounting for rental income over the holding period and the eventual sale proceeds.
  • Multiple IRRs: If a project has cash flows that change sign more than once (e.g., an environmental cleanup cost at the end), there may be multiple mathematical solutions for IRR. In such cases, use NPV analysis instead.

Related Calculators

XIRR Calculator →Calculate XIRR for your mutual fund SIP, lumpsum, or portfolio with irregular cash flows. Get the true annualised return on any investment in seconds.
CAGR Calculator →Calculate the Compound Annual Growth Rate of any investment instantly. Enter your initial value, final value, and time period to find CAGR or projected returns.
Compound Interest Calculator →Calculate how your investment grows with compound interest. Get future value, total interest earned, and see the impact of regular contributions — free and instant.

Related Terms

XIRRExtended Internal Rate of ReturnCAGRCompound Annual Growth RateROIReturn on InvestmentAmortisationLoan Amortisation
Frequently Asked Questions
What is a good IRR for an investment?
A 'good' IRR must exceed the Minimum Acceptable Rate of Return (MARR) or hurdle rate — typically the cost of capital or a benchmark return. For Indian real estate projects, IRRs above 15–18% are considered attractive. For venture capital, IRRs above 20–25% are typical targets.
What is the difference between IRR and NPV?
NPV (Net Present Value) tells you the absolute value added by a project in today's rupees — whether it is positive (worth doing) or negative (destroys value). IRR tells you the rate of return at which NPV equals zero. Both are complementary; IRR is a rate, NPV is a value.
Can IRR be misleading?
Yes. IRR can be misleading for projects with unconventional cash flows (multiple sign changes), as there can be multiple IRRs. Also, IRR does not account for the scale of investment — a small project with a 30% IRR may add less value than a large project with a 15% IRR. Modified IRR (MIRR) addresses some of these issues.
How is IRR different from XIRR?
IRR assumes cash flows occur at regular periodic intervals (e.g., annually). XIRR accounts for the exact dates of each cash flow, making it more accurate for real-world investments like SIPs, real estate projects, or business cash flows with irregular timing.
How do I calculate IRR in Excel?
Use the =IRR(values, [guess]) function in Excel, where 'values' is an array of cash flows starting with the initial investment (as a negative number) followed by future cash flows. For irregular dates, use =XIRR(values, dates) instead.