IRR Formula

IRR Formula

IRR can be calculated with the help of following formula. It is important that IRR is an estimated calculation only. IRR tell us about the rate, where NPV will become zero. IRR is return of the project, if such return is greater than expected return, then project is to be selected, otherwise rejected.

R_L+ {  NPV_L          } x (R_H-R_L)

         NPV_L-NPV_H

R_L= Lower rate of Return

R_H= Higher Rate of Return

NPV_L = NPV with Lower rate of Return

NPV_H= NPV at higher rate of return

Example

Year

0     100,000

1      30,000

2      30,000

3      35,000

4      15,000

Calculate IRR?

Solution

We assume that IRR falls between 10% & 15%.

Year                  Discount           PV @10%     Discount           PV @ 15%

0     100,000         1                   (100,000)                           (100,000)

1      30,000       (1+10%)^-1          27,272        (1+15%)^-1        26,086  

2      30,000       (1+10%)^-2          24,793       (1+15%)^-2        22,684   

3      35,000       (1+10%)^-3          26,296       (1+15%)^-3         23,013   

4      32,000       (1+10%)^-4          21,856        (1+15%)^-4        18,296

NPV                                             217                                (9,921)            

R_L+ {  NPV_L          } x (R_H-R_L)

         NPV_L-NPV_H

= 10% + [ 217/(217- (-9921)]x [ 15%-10%)

=10%+ [217/10,138] x [5%]

=10.10%