IRR – Napkin Finance

IRR

Crunch the Numbers

The internal rate of return, or IRR, is a measure of an investment’s or a project’s profitability.

Investors and companies use the metric to measure or estimate their returns on a particular use for their money.

How used

The IRR can be used in two main ways:

To estimate future returns To measure past returns
Data you need
  • Estimates of how much cash you’ll invest in the project and when
  • Estimates of how much cash you’ll receive back from the project and when
  • Records of how much cash you invested in the project and when
  • Records of how much cash you received from the project and when
What IRR tells you
  • An estimate of your return rate over the life of the project
  • What your return was on that particular project
Who uses

Companies can use IRRs to evaluate past or potential future projects, such as:

  • Opening a store in a new market
  • Buying new equipment
  • Building a new factory
  • Launching a new product

Investors can use IRRs to evaluate some types of investments. In particular, it’s often used with:

IRR vs. NPV

The IRR isn’t the only metric companies have for evaluating projects. They can also consider a project’s net asset value, or NPV.

Here’s how IRRs and NPVs compare:

IRR NPV
What it is A percentage return figure A dollar value
What it means The annualized return rate the company earned (or expects to earn) on its project The dollar amount of value the project adds to the company
Best uses For evaluating a single project or multiple projects that aren’t mutually exclusive For deciding which project to invest in if you have multiple options but you can only choose one
Conclusion

The internal rate of return, or IRR, is one way a company or investor can calculate potential profitability of a project or an investment. It might help a business decide between different ways of spending money or help an investor measure returns on a venture capital or private equity investment. Generally, the higher the IRR, the better the investment.

Fun facts
  • Choosing between investment options doesn’t have to be boring, especially if your choices are music royalties, collectible sneakers, or whiskey (these are all things people have actually parked their money in in hopes of a return).
  • Studies have found that Tuesday is the most productive day of the week, so it’s probably best to save your IRR calculations for then.
Key takeaways
  • The internal rate of return, or IRR, can help you determine expected or past profits from a project or an investment.
  • Calculating IRR depends on knowing how much cash you’ll put into the investment and when and how much cash you’ll receive back from the investment and when.
  • Companies can use IRRs to help decide whether or not to replace equipment, launch a new project or service, or make an investment in a new factory.
  • For individual investors, IRR is often used to calculate the performance of private equity and venture capital investments.
  • Companies can also evaluate projects using their net present values, or NPVs, which instead distill a given project into a single dollar figure of value.
IRRs are used to predict future returns. Like fortune tellers with calculators. — Napkin Finance

References

https://hbr.org/2016/03/a-refresher-on-internal-rate-of-return
https://www.doughroller.net/investing/5-weird-ways-to-invest-your-money/
https://www.cnbc.com/2015/08/26/you-invest-in-what-odd-places-to-park-money.html
https://www.cbc.ca/news/business/tuesday-most-productive-day-of-the-week-1.5260091
https://www.investopedia.com/terms/i/irr.asp
http://www.investinganswers.com/financial-dictionary/investing/internal-rate-return-irr-2130
https://www.dummies.com/business/operations-management/how-to-measure-the-rate-of-return-irr/
https://corporatefinanceinstitute.com/resources/knowledge/finance/internal-rate-return-irr/
https://www.journalofaccountancy.com/issues/2017/feb/calculate-internal-rate-of-return-in-excel.html
https://www.investopedia.com/terms/n/npv.asp
https://www.dummies.com/business/operations-management/how-to-measure-the-rate-of-return-irr/
https://www.investopedia.com/terms/m/mirr.asp
By signing up, I agree to Napkin Finance’s Terms of Service and Privacy Policy.

The simple information you need
to clean up your not-so-simple finances.