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Internal Rate of Return is another method used for cash flow valuation. IRR is a discount rate, whereby NPV equals to zero. You might use the following Excel function:

Use the IRR function in Excel to calculate a project's internal rate of return. The internal rate of return is the discount rate that makes the net present value equal to zero.

Excel allows a user to get the quarterly internal rate of return of an investment using the XIRR function. With defined quarterly periods, we will get the exact IRR. This step by step tutorial will assist all levels of Excel users to learn how to calculate the quarterly IRR in Excel. We can use IRR (Internal Rate of Return) function in Excel to calculate return from a series of even spaced cash flows. IRR Example: For example, say you invest $10,000 in a savings bond and you get $500 per year for next 5 years and then you will get $11,000 back.

There is no exact and universal formula for the IRR valuation; therefore, only approximate methods are used in practice. For example, you might use the GoalSeek function in Excel. Let's take an example of NPV calculation and try to find the value of discount rate (cell C15), so that NPV (cell C12) would equal to zero:

Moreover, you might calculate IRR by using the Newton’s method, where the root of an equation is calculated recursively based on the previous value and the angle tangent of that point:

In our case, Х – is a discount rate, f(x) – NPV, and a derivative can be calculated by knowing the value of function for two points.

For more precise results, this method has to be applied several times. Let’s add more columns for calculating several iterations:

Above picture shows the several iterations for calculating NPC at discount rate of 1%.

Let's specify the formula for calculating the discount rate. First of all, we need to calculate IRR for iteration №0. For doing this, we need to know the start value (for example, 1% - cell C15) and NPV (cell C12). Moreover, for calculating the derivative we need to know more values: let's assume that NPV is the total sum of payments (cell B12) if the discount rate is 0% (cell B15). Then the formula for IRR calculation will be equalled to the cell D15:

Copy this formula in order to apply it for cells E15:I15, and then you will see that the approximate value of IRR applied to iteration #5 will not differ from the value calculated by means of Excel functions:

Obviously, it is much easier to use the IRR formula in Excel, however in this article this calculation method is shown as an example. The principle of this method can be used in practice, especially in such situations where the use of macro commands or GoalSeek functions is not possible.

Download: IRR Calculation Excel Template (12 Kb)

Excel allows a user to get an internal rate of return and a net present value of an investment using the NPV and IRR functions. This step by step tutorial will assist all levels of Excel users in calculating NPV and IRR Excel.

Figure 1. The result of the NPV and IRR functions

Syntax of the NPV Formula

The generic formula for the NPV function is:

=NPV(rate, values)

The parameter of the NPV function is:

rate – a discount rate for the investment period
values – values representing an investment (with a negative sign) and returns over periods.

Syntax of the IRR Formula

The generic formula for the IRR function is:

=IRR(values, [guess])

The parameter of the IRR function is:

values – a range of cells containing values, including initial investment and incomes. The investment must have a negative sign, as it is a cost
[guess] – an estimated value for the expected IRR. This parameter is non-mandatory. If it’s omitted, the function will take a default value of 0.1 (=10%).

Setting up Our Data for the NPV and IRR Functions

Let’s look at the structure of the data we will use. In column B (“Amount”), we have values including initial investment and yearly incomes. In column C (“Description”) we have a description of every amount. The discount rate is in F2. In the cell F3, we want to get the IRR, while in F4 NPV.

Figure 2. Data that we will use in the NPV and IRR example

Get an NPV of Values Using the NPV Function

In our example, we want to get the NPV of the values in the range B3:B10. The result will be in the cell F4.

The formula looks like:

=NPV(F2, B4:B10) + B3

The parameter rate is the cell F2, while the values are in the range B4:B10. We omit the first value from B3, as it is negative and add it to the function result.

To apply the NPV function, we need to follow these steps:

Select cell E3 and click on it
Insert the formula: =NPV(F2, B4:B10) + B3
Press enter.

Figure 3. Using the NPV function to get the net present value of the investment

Finally, the result in the cell F4 is $3,633,448, which is the net present value of the investment and returns with the discount rate of 10%.

How To Make Irr Work In Excel

Get an IRR of Values Using the IRR Function

In this example, we want to get the IRR of the values in the range B3:B10. The result will be in the cell F3.

The formula looks like:

=IRR(B3:B10)

The parameter values is the range B3:B10

To apply the IRR function, we need to follow these steps:

Select cell F3 and click on it
Insert the formula: =IRR(B3:B10)
Press enter.

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Figure 4. Using the IRR function to get the internal rate of the investment

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Finally, the result in the cell E3 is 22%, which is the internal rate of the investment.

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Most of the time, the problem you will need to solve will be more complex than a simple application of a formula or function. If you want to save hours of research and frustration, try our liveExcelchat service! Our Excel Experts are available 24/7 to answer any Excel question you may have. We guarantee a connection within 30 seconds and a customized solution within 20 minutes.

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