How to calculate the Internal Rate of Performance

The IRR (TIRF and TIRE), is defined as that discount rate (percentage that represents a rate of interest or profitability) that "equals the present value of cash flows of income with the present value of cash flows of expenses ", being that RATE the one that is looked for, once the condition of equality to which reference is made is satisfied.

What is the internal rate of return and how to calculate it?

The internal rate of return or internal rate of return (IRR) of an investment is the geometric average of the expected future returns of said investment.

If we want to calculate the IRR, we have to do a year-by-year analysis of the project / investment balance. Here we show you how to calculate the IRR with an example:

  • With an ROI = 20% and a K = 12% (Cost of financing) and a project duration of 5 years we would obtain an accumulated balance of 82.3. The calculation of the TIRC is simple:
  • ; where D = initial outlay

For the previous example, with D = -200 we would have a TIRC of -19%, with which we would be losing money with total security. It is clear, since we invest 200 to receive a cumulative total of 82.3.

How is it expressed to the IRR

IRR is the sum of the discounted net flows of each period, from the origin, considering from the year or period 0 (zero or initial), to the year or period n (last).

  • S = summation;
  • n = is the period;
  • u = last period;
  • i = discount rate or interest or return or yield.

How to calculate the Internal Rate of Performance

For the search of the discount RATE that equals the positive flows with the negative (s), the trial and error method is used, until finding the TA $ A that satisfies the established premise.

Traditionally, the TASA is intuitively assigned and applied to the flows over and over again, until it is perceived that the result is close to the value of the source flow (negative, since it corresponds to the sum of expenditures that are made during the process of investment in fixed assets, deferred-preoperatives and initial working capital), which may well be the "zero" or "one" period. Afterwards, the values ​​are interpolated to find the one corresponding to the IRR. Two illustrative examples of calculation mechanics are presented.

Similarly, it is convenient to emphasize that it may be the case that under certain circumstances, a project may have more than one negative flow and at different times, which causes the existence and calculation of more than one internal rate of return, called MULTIPLE RATES. This procedure is not described in this note.

Tips
  • It is very important to clarify that the way in which the flows are determined depends on the type of evaluation that is desired, which may be: financial or economic, with financing or without financing.