6. Excel For Finance Tips - What is IRR ?
What is IRR ?
IRR stands for Internal Rate of Return but don't let that confuse you.
It is simply the percentage return over a specific period of an investment. It is widely used for investment appraisal.
What happens is this:
- Someone comes up with an idea for making money.
- They estimate how much it will cost them, when the money will come in, and how much.
- They calculate the IRR, and compare that to what they could get by investing their money elsewhere.
- They then try to estimate the risk of the project, and make a decision to invest depending on that.
Lets take an example: NewWebsite.com
Suppose it would cost me 5,000 per year to run NewWebsite.com in terms of hosting, computers, software, rent etc.. the opportunity cost of my time is 40,000 – this is the amount of money I could get working elsewhere. I expect to make a net profit of 20,000 in year 2, then 50,000 in year 3... 70,000 thereafter.
Is this a good project to do ?
IRR is there to help you. What does this look like in Excel ?
Here, the IRR over 10 years is 20%
- Much better than sticking my money in the bank Wow, sounds like a great project, I'll do 2 !
Training Video on: "What is IRR?"