Reading this result: the project earns an effective 15.24% a year, which clears your 10% hurdle with 5.24 points to spare.
General information only, not financial advice. Check any figure before you act on it.
What the internal rate of return actually measures
The internal rate of return is the discount rate at which a project’s net present value comes out to exactly zero. Put plainly: it is the effective annual return the project earns on the money while that money is tied up.
That definition explains why IRR is so widely used. It converts a messy stream of cash flows arriving over several years into a single percentage you can hold up against a borrowing rate, a required return, or another project. “This earns 15.2% a year” needs no explanation in a board meeting.
It also explains the awkward part. There is no formula that solves for IRR directly. The rate appears inside an exponent in every term of the equation, so the only way to find it is to try a rate, see how far the NPV lands from zero, adjust, and repeat until it converges. Every IRR function in every spreadsheet is doing exactly that behind the scenes, and so is the calculator above.
The IRR definition
Find r such that: Σ [ Cash flowt ÷ (1 + r)t ] − Initial investment = 0IRR is the r that makes NPV exactly zeroThe decision rule follows directly: accept the project when the IRR is above the return you could get elsewhere, reject it when it is below. That comparison rate is your hurdle rate, and choosing it honestly matters more than the precision of the IRR itself.
Because IRR is the rate where NPV hits zero, the two measures always agree on a single accept-or-reject decision. They can disagree when you are ranking competing projects, and that is where IRR gets people into trouble.
Three worked examples
Clear accept
Equipment purchase
A $50,000 machine returns $15,000 a year for five years. The company requires 10%.
Trying 20%: NPV = −5,140.59 (too low)
Trying 15%: NPV = +282.33 (very close)
Converges to IRR = 15.24%
That is the actual process, not a simplification — narrowing the bracket until NPV is near enough to zero. The project earns 15.24% a year against a 10% requirement, so it clears comfortably.
Marginal reject
A project that just misses
$20,000 invested returns $8,000 a year for three years, against a 10% hurdle.
Hurdle = 10.00%
Shortfall = 0.30 points
NPV at 10% = −105.18
This is the same project as the marginal example on the NPV calculator, and the two agree exactly as they must: an IRR just below the hurdle produces an NPV just below zero. When the gap is this narrow, the decision rests on forecasts that are unlikely to be accurate to 0.3 of a percentage point.
Uneven cash flows
A project that builds up
$100,000 invested returns $30,000, then $35,000, then $40,000, then $45,000 across four years. The hurdle is 12%.
IRR = 17.09%
NPV at 12% = 11,757.02
IRR handles uneven flows without difficulty — it makes no assumption that the amounts repeat. Notice that the simple total return of 50% over four years tells you very little by comparison; the annual rate is the figure that can be compared against anything else.
Where IRR misleads you
When IRR and NPV disagree
On a single accept-or-reject decision they never conflict. On ranking two competing projects they can, and it happens for two reasons: the projects are different sizes, or their cash arrives on different schedules. A small project with an early payoff will often win on IRR while losing on NPV.
When they disagree, follow NPV. It measures value created in money, which is what the business actually banks. IRR is the better number for communicating a result; NPV is the better number for making the decision.
IRR, NPV and payback compared
| Measure | Answer is in | Handles uneven flows? | Main weakness |
|---|---|---|---|
| IRR | A percentage | Yes | Multiple answers; ignores scale |
| NPV | Money | Yes | Needs a discount rate you guess |
| Payback | Years | Yes | Ignores everything after recovery |
How to calculate IRR in Excel or Google Sheets
Unlike NPV(), the IRR() function does expect your initial outlay inside the range, entered as a negative number at time zero:
=IRR(B1:B6)B1 = -50000 (the outlay), B2:B6 = the yearly inflowsIf the function returns an error, give it a starting guess as a second argument — =IRR(B1:B6, 0.1) — which helps it converge on unusual cash flow patterns. For flows on irregular dates use XIRR(), and to remove the reinvestment assumption use MIRR().
Frequently asked questions
What is a good IRR?
Any IRR above your genuine cost of capital creates value; below it destroys value. There is no universal threshold. What matters is the comparison against what that money could earn elsewhere at similar risk — a 12% IRR is excellent against a 5% alternative and poor against a 20% one.
Why can a project have more than one IRR?
Because the equation is a polynomial, and it can have as many roots as there are sign changes in the cash flows. A project that costs money at the start, earns for years, then costs money again at the end has two sign changes and can have two valid IRRs. When that happens, ignore IRR and use NPV.
Can IRR be negative?
Yes. If the total cash returned is less than the amount invested, the IRR is negative and represents the annual rate at which the investment lost value. If the project never returns enough to break even at any rate, no IRR exists at all.
What is MIRR and when should I use it?
Modified IRR replaces the unrealistic assumption that returned cash is reinvested at the IRR itself. You specify a realistic reinvestment rate instead. For projects with high IRRs, MIRR gives a materially lower and more honest figure, so it is worth calculating whenever the headline IRR looks too good.
IRR or ROI?
ROI is a simple ratio of profit to cost that ignores when the money arrives. IRR accounts for the timing of every single cash flow. For a one-in, one-out investment they tell a similar story; for anything spread over several years, IRR is far more accurate and ROI will usually look better than reality.
Does IRR account for risk?
No. It reports the return implied by the cash flows you entered and knows nothing about how likely those flows are. Risk enters through the hurdle rate you compare against — you set a higher bar for riskier projects — and through testing pessimistic forecasts, not through the IRR itself.
References
- Brealey, R. A., Myers, S. C. & Allen, F. Principles of Corporate Finance, 13th edition, McGraw-Hill Education — on the pitfalls of IRR and why NPV is preferred for ranking.
- Damodaran, A. Investment Valuation: Tools and Techniques for Determining the Value of Any Asset, 3rd edition, Wiley — on project appraisal and reinvestment assumptions.
Keep going
Written and reviewed by Ghayas Uddin, MS (Finance), financial analyst. Last reviewed 21 September 2026. Found an error? Email support@babadigit.com and we will correct it.