How to read an IRR
The decision rule is simple: accept projects whose IRR exceeds your cost of capital, since they earn more than the money costs. Investing 100,000 to receive 25,000 a year for seven years produces an IRR of about 16.3%, comfortably above a typical 10 to 12% hurdle.
IRR is solved numerically rather than by formula. This calculator uses bisection, narrowing the rate until NPV reaches zero, which is the same method spreadsheet functions use under the hood.
Where IRR misleads
IRR implicitly assumes every interim cash flow is reinvested at the IRR itself, which flatters high-IRR projects. It also ignores scale: a 30% IRR on 1,000 creates less value than a 15% IRR on 1,000,000. When ranking mutually exclusive projects, NPV is the safer guide.
Projects with alternating positive and negative cash flows can have multiple IRRs or none, which is another reason to check NPV alongside.
Frequently asked questions
What is a good IRR?
One that beats your cost of capital with room to spare. Businesses commonly use hurdle rates of 12 to 20% depending on risk; venture investments target far higher to compensate for failures.
IRR or NPV, which should I trust?
For accept/reject decisions they almost always agree. For ranking competing projects, NPV, because IRR ignores project scale and assumes reinvestment at the IRR.
Why does my spreadsheet give a slightly different IRR?
Numerical methods and convergence tolerances differ slightly between tools. Differences beyond the first decimal are rare and immaterial.
Can IRR be negative?
Yes, when total cash returned is less than the investment. It means the project loses money at any positive discount rate.
How does IRR relate to CAGR?
For a single outflow and single final inflow they are identical. IRR generalises the idea to multiple interim cash flows.
Does IRR account for risk?
No. Two projects with identical IRRs can carry very different risks. Judge the IRR against a hurdle rate that reflects the project's riskiness.