How to Calculate an IRR Investment

Grow your investments.

Internal Rate of Return (IRR) is a type of return on investment formula used to measure profitability of investments. It is calculated on an annual basis and can be used to determine the interest rate at which an investment begins to make more money than its costs. The IRR calculation is useful to calculate the yield of an investment. With the right information, it is not difficult to calculate IRR for current or potential investments. It can also be useful to calculate previous years' rate of return on your investment or portfolio.

Things You'll Need

• Financial calculator or Microsoft Excel

Instructions

1. Gather the financial information you will need to make the IRR calculation. For prior investments, determine the balances at the beginning and the end of the year. To evaluate future investments, determine your initial investment amount and the amount you expect to take out at the end of your period of investment. IRR cannot be accurately calculated for future investments that have unpredictable rates of return such as stocks, but can be used with profit expectations to evaluate business ideas.

2. Make a list of cash flows. Denote the initial investment and any additional deposits as money coming out of your pocket, since you are putting it into your investment. Similarly, list your ending balance and profits or money earned with your investment as positive numbers. This is money going in to your pocket.

3. Use a tool that is capable of calculating IRR. A hand-held financial calculator will have an equation that evaluates IRR when the cash flows are entered. The keystrokes required to make the calculation vary between calculator models. Additionally, Microsoft Excel has the IRR equation programed as a function. List your cash flows in Excel in one column and then evaluate them using the "IRR" function and highlighting the cash flow list. The equation to solve IRR uses advanced mathematical techniques and it's very difficult to calculate IRR by hand.

4. Understand the output. The IRR will be displayed as a percentage. The percentage is the return rate on the initial investment. For prior investments, if the number is positive, money is lost, and if the number is negative, money is made. A zero IRR means your investment broke even and the costs equaled the return. Similarly, the IRR will be positive for a future investment that can be expected to make money.

Tips & Warnings

• There are other online tools and computer programs available to calculate IRR.

References

• IRR definition
• discussion on IRR calculation