What is IRR?
IRR stands for Internal Rate of Return and is used to describe the average annual return on investments where deposits and payments vary in amounts.
And since the cash flows vary in amounts (uneven), standard time value of money formulas cannot be used to solve for the rate of return (they only work for equal cash flow amounts).
To calculate the internal rate of return of a series of unequal cash flows (deposits and income), those familiar with spreadsheet software (Excel™, OpenOffice Calc, etc.) can simply use the IRR function to solve for the average annual return of unequal cash flows.
However, if you are not familiar with how to set up a spreadsheet to solve for the internal rate of return of a series of unequal cash flows, you can now find a solution using this IRR Calculator -- which has a built-in IRR function.
What is IRR Function and How Does It Work?
The IRR function is an iterative process (algorithm) of trial and error used to find a rate of return that would solve for a schedule of unequal cash flows.
Specifically, the IRR function starts with a guess (usually 10%) and calculates the future values of all cash flows based on that guess. If the result is less than the actual combined future values, the function increments the guess by a small fraction of a percentage. And conversely, if the result is greater than the actual future values, the function decrements the guess by a small fraction.
Next, in either case, the function recalculates using the new guess. It then repeats the process of adjusting the guess and recalculating until either a result is found, or the preset maximum number of tries (iterations) has been reached.
Preset Limitations To Be Aware Of
Since the number of iterations required to solve extreme sets of unequal cash flows can be astronomical, I've taken the following steps to limit the amount of time it takes for this online IRR calculator to complete its calculations.
- Preliminary iteration starts with a guess of -100% and adds 1 percent to the guess until the result is greater than the actual combined future values.
- Secondary iteration starts with the guess arrived at by the primary iteration and then subtracts .0001 percent from the guess until the result is within $0.05 of the actual combined future values.
- Maximum number of both the primary and secondary tries (iterations) is set to 100,000.
If you would like to see the above limitations relaxed to give a more accurate result, please use the feedback form located beneath the calculator to let me know.