Definition
IRR is the discount rate that makes NPV equal zero. It's commonly used to compare investment opportunities.
Formula
IRR is the r where NPV(r) = 0
Example
If an investment is -$100k today and returns +$30k per year for several years, IRR is the discount rate that makes the present value of returns equal $100k.
How to use it
- IRR is sensitive to the timing of cash flows.
- Projects with multiple sign changes can have multiple IRRs or no IRR.
- Use NPV alongside IRR for clearer decision-making at a chosen discount rate.
Common mistakes
- Using IRR alone to pick between projects of different scale (use NPV too).
- Assuming IRR exists for every cash flow stream (non-standard cash flows can break it).
Measured as
IRR is the r where NPV(r) = 0
Misused when
- Using IRR alone to pick between projects of different scale (use NPV too).
- Assuming IRR exists for every cash flow stream (non-standard cash flows can break it).
Operator takeaway
- IRR is sensitive to the timing of cash flows.
- Projects with multiple sign changes can have multiple IRRs or no IRR.
- Use NPV alongside IRR for clearer decision-making at a chosen discount rate.
- Tie IRR (Internal Rate of Return) to the same balance-sheet date, scenario, and decision memo you are using elsewhere in the model.
- Document which claims, costs, or adjustments your team includes before comparing numbers across forecasts, covenants, or valuation work.
Next decision
- Quantify the impact with IRR Calculator if you need to turn the definition into an operating assumption.
- Read IRR (Internal Rate of Return): definition, formula, and how to use it if the decision depends on interpretation, policy, or trade-offs beyond the raw formula.
Where to use this on MetricKit
Calculators
- IRR Calculator: Estimate internal rate of return (IRR) for an investment using yearly cash flows.
- Investment Decision Calculator: Evaluate an investment using NPV, IRR, discounted payback, and profitability index from simple cash flow assumptions.
Guides
- IRR (Internal Rate of Return): definition, formula, and how to use it: IRR explained: what internal rate of return means, how to calculate IRR, and when IRR can be misleading (use NPV too).
- Investment decision metrics: NPV vs IRR vs payback vs PI: A practical guide to investment decision metrics: when to use NPV, when IRR misleads, and how payback and profitability index fit in.
- Capital budgeting hub: NPV, IRR, payback, and investment decisions: A practical hub for capital budgeting: use NPV, IRR, discounted payback, and profitability index together (and avoid relying on a single metric).
- NPV (Net Present Value): definition, formula, and example: NPV explained: what net present value means, how to calculate NPV, how to pick a discount rate (MARR), and common pitfalls.
- Discount rate: how to choose it for NPV and DCF: A practical guide to discount rates: what they mean, how to choose a rate (WACC vs MARR), and how to avoid common mistakes.