What is the internal rate of return (IRR) and how does it help?
The Internal Rate of Return or IRR, is a measure of your investment’s performance, and is expressed as percent return per annum. The IRR returns the internal rate of return for a series of cash flows represented by the numbers in values. These cash flows do not have to be even. However, the cash flows must occur at regular intervals, such as monthly, half-yearly or annually. Let’s say, for example, you put 800 units of money into a bank. The internal rate of return is the interest rate received for an investment consisting of payments (negative values) and income (positive values) that occur at regular periods. As you can observe in the training video the internal rate of return is about 27%. Now if the business or individual had made the investment in a machine or a computer and attained a return yearly of 3800 units the internal rate of return would have been a whopping 480%. Therefore, based on the domain knowledge of the business and use of the IRR function you could decide whether investing the money in a new project or putting the money in the bank would be financially more rewarding. While performing the calculations using the IRR function you need to ensure:
- Values must contain at least one positive value and one negative value to calculate the internal rate of return.
- IRR uses the order of values to interpret the order of cash flows. Be sure to enter your payment and income values in the sequence you want.
The syntax for IRR calculations is:
- Values is an array or a reference to cells that contain numbers for which you want to calculate the internal rate of return.
- If an array or reference argument contains text, logical values, or empty cells, those values are ignored.
- Guess is a number that you guess is close to the result of IRR.
- In most cases you do not need to provide guess for the IRR calculation. If guess is omitted, it is assumed to be 0.1 (10 percent).
- Microsoft Excel uses an iterative technique for calculating IRR.
- If IRR can’t find a result that works after 20 tries, the #NUM! error value is returned.Note:
IRR is closely related to NPV, the net present value function. The rate of return calculated by IRR is the interest rate corresponding to a 0 (zero) net present value.