what is irr 
irr or internal rate of return is a metric used in financial analysis to estimate the profitability of potential investments irr is a discount rate that makes the net present value npv of all cash flows equal to zero in a discounted cash flow analysis irr calculations rely on the same formula as npv does keep in mind that irr is not the actual dollar value of the project it is the annual return that makes the npv equal to zero generally speaking the higher an internal rate of return the more desirable an investment is to undertake irr is uniform for investments of varying types and as such can be used to rank multiple prospective investments or projects on a relatively even basis in general when comparing investment options with other similar characteristics the investment with the highest irr probably would be considered the best investopedia julie bangsubscribe to term of the day and learn a new financial term every day stay informed and make smart financial decisions sign up now the formula for irrthe formula used to determine irr is as follows 0 npv t 1tct 1 irr t c0where ct net cash inflow during the period tc0 total initial investment costsirr the internal rate of returnt the number of time periods begin aligned text 0 text npv sum t 1 t frac c t left 1 irr right t c 0 textbf where c t text net cash inflow during the period t c 0 text total initial investment costs irr text the internal rate of return t text the number of time periods end aligned 0 npv t 1 t 1 irr tct c0 where ct net cash inflow during the period tc0 total initial investment costsirr the internal rate of returnt the number of time periods the manual calculation of the irr metric involves the following steps because of the nature of the formula irr cannot be easily calculated analytically and instead must be calculated iteratively through trial and error or by using software programmed to calculate irr e g using excel 1using the irr function in excel makes calculating the irr easy excel does all the necessary work for you arriving at the discount rate you are seeking to find here is a simple example of an irr analysis with cash flows that are known and annually periodic one year apart assume a company is assessing the profitability of project x project x requires 250 000 in funding and is expected to generate 100 000 in after tax cash flows in the first year and grow by 50 000 for each of the next four years image by sabrina jiang investopedia 2020in this case the irr is 56 72 which is quite high excel also offers two other functions that can be used in irr calculations the xirr and the mirr xirr is used when the cash flow model does not exactly have annual periodic cash flows the mirr is a rate of return measure that includes the integration of the cost of capital and the risk free rate 23understanding irrthe ultimate goal of irr is to identify the rate of discount which makes the present value of the sum of annual nominal cash inflows equal to the initial net cash outlay for the investment several methods can be used when seeking to identify an expected return but irr is often ideal for analyzing the potential return of a new project that a company is considering undertaking think of irr as the rate of growth that an investment is expected to generate annually thus it can be most similar to a compound annual growth rate cagr in reality an investment will usually not have the same rate of return each year usually the actual rate of return that a given investment ends up generating will differ from its estimated irr 