Investment decisions
Internal rate of return (IRR)
Find a project's break-even rate, and learn when IRR gives the wrong answer.
18 minintermediateMembers
Learning objectives
- Calculate IRR and confirm that NPV is zero at the IRR
- Compare IRR with a hurdle rate
- Recognize when IRR misleads: scale and multiple IRRs
- Explain what MIRR changes about the reinvestment assumption
The internal rate of return is the discount rate at which a project's NPV is exactly zero. It's the project's own break-even return: for a conventional project (an outlay followed by inflows), if IRR exceeds the cost of capital (the hurdle rate), NPV is positive.
In general IRR has no closed-form formula; spreadsheets find it by trial and error. That's why IRR() occasionally can't find an answer (#NUM!).
0 = CF₀ + CF₁ ÷ (1 + IRR) + CF₂ ÷ (1 + IRR)² + … + CFₙ ÷ (1 + IRR)ⁿ
- CFₜ
- net cash flow at the end of year t (CF₀ is today's investment)
- IRR
- the rate that makes NPV exactly zero
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