{"id":4542,"date":"2021-05-31T21:11:17","date_gmt":"2021-05-31T20:11:17","guid":{"rendered":"https:\/\/www.simtrade.fr\/blog_simtrade\/?p=4542"},"modified":"2026-03-08T15:23:46","modified_gmt":"2026-03-08T15:23:46","slug":"internal-rate-return","status":"publish","type":"post","link":"https:\/\/www.simtrade.fr\/blog_simtrade\/internal-rate-return\/","title":{"rendered":"The Internal Rate of Return"},"content":{"rendered":"

\"img_SimTrade_Photo1_Raphael_Roero_de_Cortanze\"<\/a><\/p>\n

In this article, Rapha\u00ebl ROERO DE CORTANZE<\/a> (ESSEC Business School, Grande Ecole<\/i> Program – Master in Management, 2019-2022) explains the financial concept of internal rate of return (IRR).<\/p>\n

What is the Internal Rate of Return?<\/h2>\n

The Internal Rate of Return (IRR or \u201cTRI\u201d \u2013 \u201ctaux de rendement interne\u201d in French) of a sequence of cash flows is the discount rate that makes the Net Present Value (NPV or \u201cVNP\u201d or \u201cVAN\u201d for \u201cvaleur nette pr\u00e9sente\u201d or \u201cvaleur actuelle nette\u201d in French) of this sequence of cash flows equal to zero.<\/p>\n

\"Screenshot<\/p>\n

In order to calculate the IRR, two methods can be used. First of all, use the Excel \u201cIRR\u201d formula on the sequence of cash flows, which will automatically display an approximate value for the IRR. Nonetheless, if Excel is not available for performing the IRR calculation, you can use the dichotomy method (which is indeed used by Excel). The dichotomy method uses several iterations to determine an approximation of the IRR. The more iterations are performed, the more accurate the final IRR output is. For each iteration, the table below assesses whether the NPV using the \u201cAverage\u201d discount rate is positive or negative. If it is negative (resp. positive), it means the IRR is somewhere in between the \u201cLower bound\u201d (resp. \u201cUpper bound\u201d and the \u201cAverage\u201d) and the next iteration will thus keep the same \u201cLower bound\u201d (resp. use the \u201cAverage\u201d as the new lower bound) and use the \u201cAverage\u201d as the new \u201cUpper bound\u201d (resp. keep the same \u201cUpper bound\u201d). After 10 iterations, the table displays an IRR of 18,457%, which is an approximation to the nearest hundredth of the 18,450% IRR calculated with the Excel formula.<\/p>\n

\"Screenshot<\/a><\/p>\n

The IRR criterion<\/h2>\n

In the same way as the NPV, the IRR can be used to evaluate the financial performance of:
\nA tangible investment: the IRR criterion can be used to evaluate which investment project will be the most profitable. For instance, if a firm hesitating between Project A (buying a new machine), Project B (upgrading the existing machine) and Project C (outsourcing a fraction of the production), the firm can calculate the IRR of each project and compare them.
\nA financial investment: whether it is a bank investment or a private equity investment (purchase of a company) the IRR criterion can be used to sort different projects according to their financial performance.<\/p>\n

Disaggregating the IRR<\/h2>\n

Investors and especially Private Equity firms often rely on the IRR as one measure of a project\u2019s yield. Projects with the highest IRRs are considered the most attractive. The performance of Private Equity funds is also measured through the IRR criterion. In other words, PE firms use the IRR to select the most profitable projects and investors look at the IRR of PE funds when choosing to which PE firms\u2019 fundraising campaign, they will participate in.<\/p>\n

Nonetheless, IRR is the most important performance benchmark for PE investments, the IRR does not go into detail. Indeed, disaggregating the IRR can help better understand which are the different components of the IRR:<\/p>\n