ON THIS PAGE
Considering an operating lease?
Lease machinery, equipment and fit-outs from ₹25 lakh to ₹100 crore.
Check eligibilityWhat IRR is
IRR answers one question: at what annual rate do the cash going out and the cash coming in exactly balance, once timing is taken into account? Working it out takes four steps.
1
Cash flows: list every amount in and out, with when it happens, including deposits, fees and any value at the end.
2
Trial rate: discount each flow at a trial rate and add them up to get the net present value (NPV).
3
Iterate: adjust the rate until NPV is zero. Spreadsheets do this with IRR, or XIRR when dates are irregular.
4
Compare: an investment's IRR should beat the hurdle rate. For a lease or loan, IRR is the cost, so lower is better.
IRR is easy to quote and compare, which is why it is widely used. It also has known blind spots, so it works best alongside NPV rather than in place of it.
When IRR is reliable
IRR gives a clear answer for simple cash flows. In other cases NPV at your cost of capital is the safer guide.
WHAT CHANGES
IRR works well
Lean on NPV instead
Cash flow pattern
One outflow, then inflows
Signs change more than once
Choosing between projects
Similar size and life
Different size or life
Reinvestment of cash
Realistic at the IRR
Only possible at a lower rate
Answer you get
A rate to compare
Value added in rupees
How to calculate IRR
Find the rate r for which CF₀ + CF₁ ÷ (1 + r) + CF₂ ÷ (1 + r)² + … + CFₙ ÷ (1 + r)ⁿ = 0. There is no direct formula, so the rate is found by trial and error, which spreadsheet functions do for you.
Cost of a lease or loan.
Treat the amount financed as an inflow and each rental, deposit and fee as an outflow. The IRR is the cost. Compare offers on the same basis and after tax.
Known limits.
Cash flows that change sign more than once can give several IRRs or none. IRR also assumes interim cash earns the IRR, which flatters high-return projects.
Annualise a monthly IRR as (1 + monthly rate)¹² − 1, not monthly rate × 12.
Where IRR is used
Screening a warehouse automation project
ILLUSTRATIVE
A logistics company can spend ₹1 crore on sortation equipment that saves ₹30 lakh a year for five years, with no value at the end. The IRR is the rate that makes those savings worth exactly ₹1 crore today: about 15.2%. Its hurdle rate is 12%, so the project clears it. As a check, the NPV at 12% is ₹30 lakh × 3.6048 − ₹1 crore, or about ₹8.1 lakh, which is positive. Separately, the CFO compares a lease quote and a bank loan by working out the IRR of each one's cash flows to see which costs less.