{"id":254491,"date":"2023-09-25T09:28:32","date_gmt":"2023-09-25T09:28:32","guid":{"rendered":"https:\/\/imarticus.org\/?p=254491"},"modified":"2024-07-01T13:16:35","modified_gmt":"2024-07-01T13:16:35","slug":"internal-rate-of-return-irr-definition-benefits-and-guide","status":"publish","type":"post","link":"https:\/\/imarticus.org\/blog\/internal-rate-of-return-irr-definition-benefits-and-guide\/","title":{"rendered":"Internal Rate of Return (IRR): Definition, Benefits and Guide"},"content":{"rendered":"

IRR or internal rate of return is a metric to calculate project revenue without considering external economic factors. This tool is more useful when used for comparative analysis rather than a single, isolated value. It helps in making better investment decisions and smarter project choices.<\/p>\n

For a career in investment banking<\/a><\/strong>, it is vital to know the details of a variety of financial tools, one of them being the IRR. Here's your guide to know its definition, calculation, benefits and drawbacks, and much more.<\/p>\n

Defining Internal Rate of Return
\n<\/strong><\/h2>\n

Internal rate of return or IRR is a tool in financial analysis, which helps to estimate the profitability or revenue from a potential investment venture. It is a discount rate at which the return from any project is equal to its original investment value. Thus, this tool helps to achieve a break-even point by equalising the total cash inflow and outflow and helps to determine the most profitable project.<\/p>\n

Formula<\/strong><\/p>\n

Internal rate of return works to make the net present value or NPV zero, thus ensuring a break even. It can be calculated by the following formula:<\/p>\n

IRR Formula<\/p>\n

Calculating IRR<\/strong><\/p>\n

The simplest way to calculate the internal rate of return is to use Microsoft Excel, which is one vital tool taught in any investment banking course<\/a><\/strong>. The ideal way to determine IRR is the trial and error method, where you have to take various discount rates to make NPV zero. It is in the character of IRR that you cannot calculate it analytically, but rather use trial and error methods.<\/p>\n

Given are the steps to calculate IRR:<\/strong><\/h3>\n
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  1. Take the project's offered discount rate to calculate NPV.<\/li>\n
  2. Fill the remaining values in the formula.<\/li>\n
  3. Check if the value is positive, only then proceed to the next step.<\/li>\n
  4. Now the NPV is taken as zero. In the formula, fill in an assumed discount rate by trial and error method. This will give an NPV value very close to zero.<\/li>\n
  5. Finally, compare the Discounted Rate with IRR. If the NPV is positive, and the IRR is higher than Discounted Rate, then you can invest in the venture.<\/li>\n<\/ol>\n

    What is the purpose of IRR?<\/strong><\/h3>\n

    Internal rate of return helps in the comparative analysis of projects and helps to determine which project offers the highest revenue. It further helps in understanding whether it is profitable to establish fresh operations or expand the existing ones.<\/p>\n

    For instance, if you have a textile shop, you can use IRR to determine whether you should open a new branch or renovate and expand the already existing shop. Both avenues can be worthwhile for the investor. However, the comparison proves that either one is more profitable and logical.<\/p>\n

    What Factors Can Affect IRR?<\/strong><\/h3>\n

    Given below are some vital factors which affect IRR:<\/strong><\/p>\n