The Internal Rate of Return (IRR) is actual return on the investment. It is the rate that makes the present value of the cash flows exactly equal to the initial investment.

Example:

An investor will receive $3,000 per year for five years on an investment $10,000. What is the internal rate of return to the nearest percent?

There is no way to calculate the internal rate of return but experiment with the numbers. Using 15% as the discount rate, the present value of the annuity for 5 years is:

3.352155 x $3,000 = $10,056

If the annuity had been only $2,500, then the discount rate to make the cash flows equal $10,000 would be 8%.

3.992710 x $2,500 = $9,982

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