# Overview

#### Main Menu Name: **IRR**

Calculates an investment's yearly cumulative cash flow position (positive or negative) of an investment, year by year. It also calculates the internal rate of return (IRR) on the investment for periods up to 40 years.

### In this article:

# Background

The IRR of an investment is the "discount rate" that causes the present value of future cash flows from the investment to be equal to its current cost. The investment's IRR is used to calculate the percentage rate of return that will be produced by a series of cash outflows and inflows.

IRR computations are used to compare investments or to determine if an investment will be profitable. For example, assume an individual wants to purchase an office building as an investment. Before making the purchase, he should consider the following: (a) the time value of money, (b) the total income that will be received, and (c) funding that will be needed to continue the rent flow (such as repair and renovation costs). He pays $50,000 in initial outlay, estimates net income of $10,000 a year, and plans to keep the building for 10 years.

Given these facts, the calculation determines the IRR to be 20.2%. The individual then compares this discount rate to the cost of borrowing money. If $50,000 can be borrowed for less than 20.2% (and other factors are positive), the investment would be appealing. If the cost of borrowing money were more than 20.2%, the investment would not be profitable.

- The IRR approach assumes that future cash inflows can be invested at the same rate as the IRR. This rate, in fact, may not be available.
- Cash flows are discounted at the same IRR rate. Occasionally, however, an investor will receive no cash inflow to correspond to a cash outflow. An example of this is leveraged real estate investments. Cash needs must therefore be satisfied with available or borrowed funds. The IRR approach, however, does not recognize the earning rate that money on hand could yield, or the expense incurred by borrowing.
- At times, an investment will produce both positive and negative cash flow, which may cause multiple internal rates of return.

# Getting Started

The IRR of an investment is the "discount rate" that causes the present value of future cash flows from the investment to be equal to its current cost. The investment's IRR is used to calculate the percentage rate of return that will be produced by a series of cash outflows and inflows.

IRR computations are used to compare investments or to determine if an investment will be profitable. For example, assume an individual wants to purchase an office building as an investment. Before making the purchase, he should consider the following: (a) the time value of money, (b) the total income that will be received, and (c) funding that will be needed to continue the rent flow (such as repair and renovation costs). He pays $50,000 in initial outlay, estimates net income of $10,000 a year, and plans to keep the building for 10 years.

Given these facts, the calculation determines the IRR to be 20.2%. The individual then compares this discount rate to the cost of borrowing money. If $50,000 can be borrowed for less than 20.2% (and other factors are positive), the investment would be appealing. If the cost of borrowing money were more than 20.2%, the investment would not be profitable.

The IRR approach is not without weaknesses and should be used only in conjunction with other methods of investment analysis. These weaknesses include the following:

- The IRR approach assumes that future cash inflows can be invested at the same rate as the IRR. This rate, in fact, may not be available.
- Cash flows are discounted at the same IRR rate. Occasionally, however, an investor will receive no cash inflow to correspond to a cash outflow. An example of this is leveraged real estate investments. Cash needs must therefore be satisfied with available or borrowed funds. The IRR approach, however, does not recognize the earning rate that money on hand could yield, or the expense incurred by borrowing.
- At times, an investment will produce both positive and negative cash flow, which may cause multiple internal rates of return.

# Entering Data

**Starting Year:**Enter the staring year (calendar year).**Number of Years:**Enter the number of years for the analysis.**Amount:**Enter the estimated outflows of income for each year. Inflow is entered as usual. Outflow is designated with a minus (-) sign. Forty years of cash flow can be recorded. The first cash flow input must always be negative.

# Results

The program computes the cumulative cash flow position (positive or negative) for up to 40 years and also the internal rate of return for each successive and cumulative time period.

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