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Internal Rate of Return (IRR) Tutorial

August 26, 2021 By Vash Leave a Comment

Internal Rate of Return (IRR) Tutorial

Key Snapshots

IRR Formulas

IRR formula for single cash flow:

    \[IRR = \sqrt[\leftroot{-2}\uproot{2}n]{\frac{CF_n}{I}} - 1\]

Here, IRR represents the Internal Rate of Return. CF_n reflects the cash flow that occurs at time n, and I denotes the initial investment.

IRR formula for multiple cash flows (using interpolation):

    \[IRR = r_1 + \frac{NPV_1}{NPV_1 - NPV_2}(r_2 - r_1)\]

Here, IRR represents the Internal Rate of Return.

NPV_1 represents the positive Net Present Value that is obtained by using a discount rate r_1.

NPV_2 represents the negative Net Present Value that is obtained by using a discount rate r_2.

The IRR formula here uses interpolation, relying on the fact that the IRR is the point at which NPV is equal to 0.

IRR formulas on Excel®:

  • RATE
  • IRR

IRR Use Cases

The IRR is relevant for:

  • Capital Budgeting / Investment Appraisal
  • Estimating the Yield to Maturity (YTM) of bonds

Related Resources

  • Video tutorial on NPV: Net Present Value (NPV) Tutorial
  • Articles:
    • How to Calculate NPV (Net Present Value) – Step By Step Walkthrough
    • How To Calculate IRR – Step-by-Step Walkthrough
  • Course on Investment Appraisal / Capital Budgeting: Investment Appraisal Course

Filed Under: Video Tutorials

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