Developing the Internal Rate of Return Formula
1. Make a list of all the cash flows involved in the project. The money received is denoted as a positive value and the money invested is denoted by a negative value. The money invested generally includes the initial investments and other additional deposits which are invested at the start of the project. The money received generally includes the profits earned and the ending balance.
Based on this, the internal rate of return formula can be devised as follows:
where CF represents the cash flow generated in each time period; n represents the last time period and r represents the IRR value.
2. It is not easy to calculate IRR without the use of a financial calculator or Excel program. If calculating manually, one has to make use of the trial and error method. Microsoft Excel has the IRR equation programmed into it as a function. To use Excel, enter the cash flows in one column, highlight the same and evaluate using the “IRR” function.
3. Once the IRR is calculated, it is important that one understands how to interpret the results. The IRR is a percentage value. For a future investment, if the IRR is positive, then, the investment is expected to give returns. A zero IRR indicates that the project would break even.