IRR Example

Here is simple step by step procedures which can be followed to calculate IRR for a cash flow :

  1. Guess the value of r and calculate the NPV of the project at that value.
  2. If NPV is close to zero then IRR is equal to r.
  3. If NPV is greater than 0 then increase r and move to step 5.
  4. If NPV is smaller than 0 then decrease r and move to step 5.
  5. Recalculate NPV using the new value of r and go back to step 2.

Where Formula of NPV is :

NPV = ∑ {PCF / (1+R)^T} - I

Where
R = Interest Rate
PCF - Period Cash Flow
I - Initial investment
T = Number of Time Periods

Hand Example Of IRR Calculation :

Question

Find the IRR of an investment having initial cash outflow of 320000.The cash inflows during the first, second, third, fourth and fifth years are expected to be 82800, 85610, 86900, 94530 and 98570 respectively.

Solution :

You find it by first guessing then keep guessing and calculating until you get a Net Present Value of zero.

NPV at 10% discount rate = 17083.53

Since NPV is greater than zero we have to increase discount rate, thus

NPV at 11% discount rate = 8384.46

But it is still greater than zero we have to further increase the discount rate, thus

NPV at 12% discount rate = 36.83

NPV at 13% discount rate = -7977.54

Since NPV is fairly close to zero at 12% value of r, therefore IRR ≈ 12%