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Given an investment opportunity, which quotes an IRR of 10% (for example), is it possible to calculate an approximate return on investment? Let's say the project life is 5 years and money invested is $10,000.

I understand that IRR is different to ROI but sometimes these opportunities only quote an IRR, and it can be difficult to work out whether or not they're worthwhile.

I've read in some places that the IRR can be roughly used as an interest rate - is that true?

Thanks

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ROI and IRR are related concepts. Generally speaking, they both give you an idea of the 'return' you would get on an investment. ROI is very basic in that it doesn't account for the length of time of the investment.

IRR is more sophisticated in that it can be used on investments that have multiple payouts and costs. You take the up-front cost and put it on the left hand side of the equation and discounted payments (with an unknown rate) on the right hand side, then solve for the discount rate that makes them equal.

If your investment lasts one year and only pays out at the end, then IRR and ROI are, in fact, the same. IRR numbers are generally annualized, so a reasonable way to compare and ROI and and IRR is to annualize the ROI. Let's say your ROI is over a period of 8 months, then you would get the annualized ROI,

AROI = (1+ROI)^(12/8) - 1

This could reasonably be compared with an IRR. Replace 8 above with the length of time in months of your ROI investment. I suppose if you really insist on the IRR to be converted to a time frame comparable with your ROI, you could de-annualize the IRR. In the 8 month case that would be

DIRR = (1+IRR)^(8/12) -1

Can we think of IRR roughly as an interest rate? Well, it's not actually an interest rate, but it's closely enough related that you can think of it as one for comparison purposes.

  • Thanks for your in depth explanation, that's very helpful @farnsy – Michael Bates Nov 22 '18 at 10:21

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