Finding the Internal Rate of Return (IRR)

For a business proposition, an individual always start the business with some initial investment.  After a regular internal, which may be a month or a quarter or a year, one takes stock of things which may also be required by the land laws.  One must be having some financial outcome just after the completion of an interval, which may be positive (net return or income of that interval) or a further net investment (which can be taken as negative income or return).  Thus, after some periods of time intervals, one may be having a series of positive and negative incomes/investments recorded after each of the regular interval including the initial investment.  If one is interested in knowing the overall return from one’s investments over the entire period from initial to the present time, one may adopt the following procedure.

The algorithm one may adopt is:

1.    Fix a point of time; say the beginning of the said business or the present/ current time.

2.    With proper sign (negative for net investment and positive for net income at the end of the regular interval) list all the financial cash flows over the period from start to present time.

3.    Take the entire series of cash flows valued at the fixed point of time settled at step 1 by assuming a rate of return (r%) which can be one’s gut feeling or first rough guess.  Normally one may take it as 10%, if not known.

4.    Add all the Net Values at the fixed point of time to zero.

5.    Solve the value of r with iterative method (numerical method).

6.    Value of r is your Internal Rate of Return (IRR).

The same can also be obtained by fitting the financial function (IRR) in EXCEL package of MS office, if available.