How To Calculate An Internal Rate of Return (IRR)

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There are three primary methods of evaluating the financial return of a capital investment. You can look at a static or pro forma return on investment (ROI), an internal rate of return (IRR) or the net present value (NPV) of an investment. Actually, you can use all three methods to have a more complete financial picture. There are other less useful but widely used methods to evaluate the return on an investment such as calculating the payback period.

The Internal Rate of Return (IRR) calculation takes into account the time value of money. As mentioned above, time value of money is a financial principle that a dollar today is worth more than a dollar tomorrow due to expected or realized inflation. In other words the longer you have to wait for an investment to return a dollar the less it is worth to you today. The IRR calculation takes a series of investment inflows and capital outflows and returns the average annual rate of return over the investment period to yield a zero net present value (NPV).

For example, an investment that has a ten-year time horizon might return a 10% IRR which is the average annual return of the investment. Some years the return will be higher and some years it will be lower. IRR is useful for comparing strategic investments that have the same time horizon but different planned cash flow streams. It also provides clarity because it discounts future cash flow.

Choose carefully from among your investment options during your financial planning process. You have a finite amount of disposable cash for growth opportunities. Your strategic investment plan should include a calculation of return on investment (ROI), net present value (NPV), and internal rate of return (IRR) for each business opportunity.

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About Michael Shelton

Your Business Coach Facilitating Delegation and Work Group Engagement Michael Shelton has over twenty-five years of business and military accomplishments, including extensive experience with one of the largest, publicly traded real estate investment trusts (REIT). He is a qualified business coach with assignments in cross-functional work group management, strategic planning, unit leadership, joint venture acquisitions, executive education, mentoring, training and merger integration. Michael has accumulated best practices for building committed work groups from more than $4 billion of capital markets transactions and commercial property development. He served as a commissioned officer and helicopter pilot in the U.S. Army, and earned his MBA from The University of Arizona. Michael has served as a major conference panelist and is the author of Cash Flow Rich, Winning Ways to Evaluate and Finance Real Estate. Today, he helps business owners get more work group engagement as President and CEO of Shelton Business Services, LLC in Scottsdale, Arizona. Disclaimer: I don't offer investment, legal or tax advice. Talk to your broker, accountant or lawyer for investment, tax and legal help. I might own stock in the companies I mention on-line. My posts, tweets and other on-line activity are my personal thoughts and don't represent my employer or company.
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One Response to How To Calculate An Internal Rate of Return (IRR)

  1. Pingback: How to Calculate the Net Present Value (NPV) of a Capital Investment | Borrowing Money: Your Handy Guide

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