1. What is Internal Rate of Return (IRR)?

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of all cash flows equal to zero in a discounted cash flow analysis. It's commonly used to evaluate the profitability of potential investments.

2. How Does the IRR Calculator Work?

The calculator uses the Newton-Raphson method to solve the IRR equation:

Where:

• \( CF_t \) — Cash flow at time period t
• \( IRR \) — Internal rate of return
• \( n \) — Number of periods

Explanation: The calculator iteratively finds the discount rate where the sum of discounted cash inflows equals the initial investment (outflow).

3. Importance of IRR Calculation

Details: IRR is a key metric in capital budgeting that helps investors compare the profitability of different investments. A higher IRR typically indicates a more desirable investment.

4. Using the Calculator

Tips: Enter cash flows as comma-separated values (negative for outflows, positive for inflows). The initial guess helps the algorithm converge faster (default is 10% or 0.1).

5. Frequently Asked Questions (FAQ)

Q1: What's a good IRR value?
A: Generally, an IRR higher than the cost of capital is desirable. The higher the IRR, the more attractive the investment.

Q2: Can IRR be negative?
A: Yes, a negative IRR indicates the investment would lose money at that rate.

Q3: What are limitations of IRR?
A: IRR doesn't account for project size, assumes reinvestment at IRR rate, and can give multiple solutions for alternating cash flows.

Q4: How is IRR different from ROI?
A: ROI shows total return percentage, while IRR shows annualized effective compounded return rate.

Q5: When is IRR not reliable?
A: For projects with unconventional cash flow patterns (multiple sign changes) or when comparing projects of different durations.