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Calculate Internal Rate of Return Online

IRR Calculator
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There are multiple ways in which the performance of an investment can be evaluated. Among them, some common methodologies involve calculating the net present value (NPV), return on investment (ROI) and Internal Rate of Return (IRR). 

Specifically, when prioritising different business ventures or scrutinising some investment prospects, the internal rate of return stands out as a vital metric. 

In this guide, we will talk about an online IRR calculator and how to use it in different scenarios. 

Table of Contents

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What is the Internal Rate of Return?

The internal rate of return (IRR) is a crucial parameter that is perceived to estimate the annualised return rate of any project or investment. Simply put, it is the rate at which an investment's Net Present Value (NPV) of all cash flows hits zero.

You can use this metric to find out the compounded returns of an investment. For this, you would need two different inputs:

  • The value of the cash outflows/ inflows

  • Timing or the coinciding dates

Next, by putting these values into a set formula, you can predict the rate at which an investment may earn returns. Contrarily, you can also calculate IRR online using a calculator from a credible website.

Formula to Calculate Internal Rate of Return

Here’s the internal rate of return formula:

Internal Rate of Return (%) = (Future Investment Value / Present Value)^1/Periods - 1

Assuming all other metrics are favourable, a higher internal rate of return will always indicate a more profitable investment. 

If you follow the concepts, you may even hold the IRR as the same as any investment’s actual rate of return. However, for this, the net present value of such projects must be equal to zero. 

How to Calculate the Internal Rate of Return Online?

Navigate to an online IRR return calculator available on a credible website and follow the steps mentioned below:

Step 1

Present all the cash flows related to an investment chronologically.

Step 2

Mention the expected rate of return. This figure denotes the minimum return that you find acceptable to start investing. 

Step 3

Hit the ‘Calculate’ option on the IRR calculator.

Step 4

As an output, you can see the measured IRR for a project or investment. 

Example of IRR Calculation

Below, we have discussed an internal rate of return example better to explain the functioning of the online IRR calculator.

Mr. Mehra owns a gym and is considering investing in new cutting-edge equipment. This machine will cost him ₹5 Lakhs upfront. However, he estimates that it will attract more members and increase his gym's revenue by ₹2 Lakhs in the first year, ₹3 Lakhs in the second year, ₹5 Lakhs in the third year, and ₹6 Lakhs in the fourth year.

Based on the above assumptions, the IRR will be approximately 25.46%. 

Calculating the IRR is highly recommended using an online calculator or MS Excel. It involves solving a complex polynomial equation, which is iterative, making manual calculations often impractical.

What are the Limitations of the Internal Rate of Return?

While making an investment decision, one cannot singularly rely on the internal rate of return. The reasons are as follows:

IRR is Highly Sensitive to the Timing of Cash Flows

Slight changes in the timing of cash inflows or outflows can significantly impact the IRR. This sensitivity can lead to misleading results, especially when dealing with projects or investments with irregular cash flow patterns.

IRR Can Indicate Artificially Inflated Returns

In investments with shorter holding periods, IRR can generate artificially high returns, which can be unsustainable if the holding period is hypothetically extended. 

IRR Does Not Consider Potential Costs

IRR takes into account the injected capital to determine the projected cash flow. However, it does not consider potential costs like fuel and maintenance expenses, which tend to vary over time. This leads to incorrect results, which can affect future profits.

IRR Can Be Misleading In Case of Dividend Recap

Suppose a private equity firm issues a dividend to itself after a dividend recapitalisation. In that case, this payment tends to increase the IRR irrespective of whether the multiple-of-money (MoM) meets the return hurdle requirements. In such cases, the IRR values can be very misleading.

What is the Use of Internal Rate of Return?

The IRR rule is one of the most important theories backing an investment. It helps find out the discount rate at which the Net Present Value (NPV) of an investment project can be equal to zero. 

You can measure a project’s potential to make profitable returns that will justify your investment by comparing the IRR to the required rate of return (RRR) or cost of capital. If the IRR crosses the RRR threshold, then experts generally recommend the project to be financially profitable. However, if the IRR turns out to be less than the required RRR, the project ideally needs to be declined. 

Thus, an investor can use the IRR calculator to find a crucial capital budgeting metric determining an investment’s growth rate. Consequently, higher project IRR values indicate more favourable investment returns. Therefore, you can partially rely on this metric to choose investments that can financially secure your future.

FAQs about IRR Calculator