IRR Calculator: Master Internal Rate of Return for Smarter Investment Decisions
Should you invest in that rental property? Expand your business? Comparing investment opportunities isn't guesswork—IRR gives you the numbers to make confident decisions. Here's how to use it.
What You'll Learn
- What IRR really means in plain English
- How to calculate and interpret IRR
- IRR vs NPV: When to use each one
- Real-world examples from real estate to business
- Common IRR mistakes and how to avoid them
What is Internal Rate of Return (IRR)?
IRR is the annual rate of return that makes an investment break even. In other words, it's the discount rate where the net present value (NPV) of all cash flows equals zero.
Think of it this way: If you put money in a savings account at your bank's interest rate, you'd earn a certain return. IRR tells you what equivalent interest rate your investment would need to earn to produce its actual returns.
Simple Example
You invest $10,000 today and receive:
- • Year 1: $3,000
- • Year 2: $4,000
- • Year 3: $5,000
IRR = 18.9%
This means your investment performs as if it earned 18.9% annually—like having a savings account with 18.9% interest that produces these exact cash flows.
How is IRR Calculated?
IRR is the rate (r) that solves this equation:
NPV = CF₀ + CF₁/(1+r)¹ + CF₂/(1+r)² + ... + CFₙ/(1+r)ⁿ = 0
CF₀
Initial Investment (negative)
CF₁, CF₂, CFₙ
Cash flows each period
r
The IRR we're solving for
Why Use a Calculator?
IRR cannot be solved algebraically—you need trial and error or iterative methods. That's why financial calculators and software (like ours!) use algorithms to find the rate. Doing it manually would take hours!
How to Interpret IRR Results
Good Investment
IRR > Required Return
If IRR is higher than your "hurdle rate" (minimum acceptable return), the investment is worth considering.
Example: Your IRR is 15% but you need 10% to beat inflation and opportunity cost → Good deal!
Poor Investment
IRR < Required Return
If IRR is lower than your hurdle rate, you're better off putting money elsewhere (savings, stocks, other investments).
Example: Your IRR is 6% but S&P 500 historically returns 10% → Pass!
Typical Hurdle Rates by Investment Type
IRR vs NPV: What's the Difference?
IRR
- What it is: The rate of return (%)
- Answers: "What yield does this give me?"
- Best for: Comparing investments of different sizes
- Output: Percentage (e.g., 15% IRR)
- Limitation: Doesn't show absolute dollar value
NPV
- What it is: Net present value ($)
- Answers: "How much money do I make?"
- Best for: Knowing exact dollar profit
- Output: Dollar amount (e.g., $50,000 NPV)
- Limitation: Requires choosing discount rate first
Which Should You Use?
Use IRR when:
- Comparing investments of different sizes
- Communicating returns to investors (they understand %)
- You don't have a specific discount rate in mind
Use NPV when:
- You want to know actual dollar profits
- You have mutually exclusive projects (choose one)
- Projects have unusual cash flow patterns
Best practice: Calculate both! They give complementary insights.
Real-World IRR Examples
Example 1: Rental Property Investment
Investment: Buy a rental property for $300,000
Cash Flows:
- Year 1-5: $18,000/year rental income (after expenses)
- Year 5: Sell for $380,000
IRR ≈ 10.8%
Decision: If your hurdle rate is 8-10%, this passes! Factor in tax benefits, and it could be even better.
Example 2: Business Expansion Project
Investment: $50,000 for new equipment
Cash Flows:
- Year 1: $15,000 additional profit
- Year 2: $20,000
- Year 3: $25,000
- Year 4: $20,000
IRR ≈ 34.5%
Decision: Excellent return! Much better than putting money in stocks (10%) or savings (2%).
Example 3: Equipment Replacement
Investment: $100,000 for new machine
Cash Flows (cost savings):
- Years 1-10: $15,000/year in reduced operating costs
- Year 10: $10,000 salvage value
IRR ≈ 12.8%
Decision: Good return, especially if your business typically targets 10-12% on capital investments.
Common IRR Mistakes to Avoid
Mistake #1: Ignoring Investment Size
Problem: 30% IRR on $1,000 ($300 profit) vs 15% IRR on $100,000 ($15,000 profit)
Lesson: Higher IRR doesn't always mean better investment. Consider absolute returns too.
Mistake #2: Multiple IRRs
Problem: When cash flows change signs multiple times (positive, negative, positive), IRR can have multiple solutions
Lesson: Use Modified IRR (MIRR) for projects with non-conventional cash flows.
Mistake #3: Ignoring Reinvestment Assumption
Problem: IRR assumes you can reinvest cash flows at the same IRR rate (often unrealistic)
Lesson: Be conservative. If IRR is 25%, can you really reinvest at 25% annually?
Mistake #4: Forgetting Risk
Problem: Comparing a risky startup (IRR 40%) with a stable bond (IRR 5%) isn't apples-to-apples
Lesson: Adjust your hurdle rate for risk. Higher risk = require higher IRR.
Calculate IRR for Your Investment
Use our free IRR calculator to evaluate your investments instantly. Enter your cash flows and get IRR, NPV, and more.
Quick IRR Decision Guide
Step 1: Calculate IRR
Use our calculator with your investment and expected cash flows
Step 2: Determine Your Hurdle Rate
What's your minimum acceptable return? Consider risk and alternatives
Step 3: Compare
IRR > Hurdle Rate? Investment is attractive. IRR < Hurdle Rate? Pass.
Step 4: Consider Context
Check investment size, risk level, and other factors before final decision
The Bottom Line
IRR isn't perfect, but it's one of the best tools investors have for comparing opportunities. It translates complex cash flows into a simple percentage you can compare against your alternatives.
Remember: IRR is just one metric. Use it alongside NPV, payback period, and qualitative factors like risk, market conditions, and your personal goals. The best investment decisions consider the full picture.