What is the internal rate of return (IRR) and how is it calculated?

What is the internal rate of return (IRR) and how is it calculated?

The internal rate of return (IRR) is a financial metric used to evaluate the profitability of an investment project. It represents the discount rate at which the net present value (NPV) of the project becomes zero. In other words, it is the rate of return that makes the present value of the project's cash inflows equal to the present value of its cash outflows.

To calculate the IRR, you need to set up an equation where the sum of the present values of the project's cash flows equals zero. This equation is then solved iteratively using trial and error or through the use of financial software or calculators. The IRR is the discount rate that satisfies this equation.

Alternatively, you can use the IRR function in spreadsheet software like Microsoft Excel to calculate the IRR directly. By inputting the cash flows of the project and using the IRR function, the software will calculate the IRR automatically.