Internal Rate of Return (IRR) Calculation

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The internal rate of return (IRR) is the percentage that makes the net present value (NPV) of all cash flows (both inflows and outflows) from a particular investment equal to zero. In other words, the IRR is the rate at which the present value of all future cash inflows equals the upfront cost of the project. When assessing the profitability and potential return of an investment, companies often seek to calculate this break-even rate.
Q. Find the internal rate of return (IRR) of a project assuming the initial cost is $25,000 and the cash flows are $10,000 after 1 year, $9,000 after 2 years, and $8,000 after three years.
Recall
• Net present value: NPV = −cost + PV
• Future value of compound interest: FV=PV(1+i)^n
Important Final Note:
If you encounter two (or more) different possible values for the IRR when solving for it, this typically means the investment has non-standard cash flows, such as alternating positive and negative amounts. In such a situation, the company must assess the feasibility and reasonableness of each IRR based on the context of the investment. For example, consider the economic environment, expected return rates, and how each IRR aligns with the project's financial projections and goals.

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