What IRR means and how to use it
The Internal Rate of Return is the discount rate that makes the Net Present Value of all cash flows equal to zero. In plain terms: it is the annualised compound return your investment generates per year, accounting for the exact timing and size of every cash inflow and outflow. A 20% IRR means your invested capital compounds at 20% per year across the full holding period.
IRR is the primary metric used by private equity, corporate finance teams, and infrastructure investors to evaluate capital deployment decisions. The decision rule is direct: if IRR exceeds your hurdle rate (WACC or minimum required return), the investment creates value above your cost of capital and you should proceed. If IRR falls below the hurdle rate, deploying that capital elsewhere generates more value.
MIRR (Modified IRR) solves the main weakness of standard IRR by using a separate, realistic reinvestment rate for positive cash flows rather than assuming they can be reinvested at the IRR itself. For investments with high IRRs (above 25%), MIRR tends to be significantly lower and more accurate.
The calculation methods
Standard IRR: solve for r where NPV = 0
0 = −C₀ + CF₁/(1+r) + CF₂/(1+r)² + ... + CFₙ/(1+r)ⁿ
Newton-Raphson iteration:
rₙ₊₁ = rₙ − NPV(rₙ) / NPV′(rₙ)
NPV′(r) = ∑ [−n × CFₙ / (1+r)^(n+1)]
MIRR: FV₊ = ∑ CF₊ × (1+reinvest rate)^(n−t) [positive CFs]
PV₋ = ∑ |CF₋| / (1+finance rate)^t [negative CFs (excl. year 0)]
MIRR = (FV₊ / (C₀ + PV₋))^(1/n) − 1
NPV = −C₀ + ∑ CFₙ / (1+r)^n
MOIC = ∑ positive CFs / C₀
Profitability Index = PV of future CFs / C₀
IRR assumes all intermediate cash flows are reinvested at the IRR rate. For high-IRR investments (above 20%), this assumption inflates the true return. MIRR uses a separate reinvestment rate (typically WACC or a risk-free rate + spread) for a more conservative and realistic estimate. When comparing projects, MIRR is more reliable because it eliminates the scale bias inherent in IRR.
IRR benchmarks by investment type
| Investment type | Typical IRR target | Hurdle rate context |
|---|
| Public market equities (S&P 500) | 8 – 12% | Historical average; baseline for opportunity cost |
| Corporate capital projects | 12 – 20% | Must exceed WACC by safety margin of 3–5pp |
| Real estate (stabilised, levered) | 8 – 16% | Varies by asset class, location, and leverage |
| Real estate (value-add) | 15 – 25% | Development and repositioning risk premium |
| Private equity (buyout) | 20 – 30% | Gross fund IRR before fees; net to LP is ~3–5pp lower |
| Venture capital (portfolio) | 25 – 40%+ | High failure rate requires outlier winners at 50%+ IRR |
| Infrastructure | 6 – 10% | Long life, regulated, low risk; tighter spreads |
| Renewable energy | 8 – 14% | Contracted offtake de-risks returns; leverage-dependent |
Frequently Asked Questions
What is IRR and how is it different from ROI?+
IRR is an annualised compound return rate that accounts for the timing of every cash flow. ROI is a simple percentage gain on the total investment without considering time. A 100% ROI over 10 years is approximately 7.2% IRR, while a 100% ROI over 2 years is approximately 41% IRR. The same total return looks very different when time is factored in. IRR is more useful for comparing investments with different durations and cash flow patterns because it normalises everything to an annual percentage basis. ROI is useful for quick comparisons of same-duration investments where timing differences are minimal. For most capital allocation decisions, IRR alongside NPV is the standard.
What is MIRR and when should I use it instead of IRR?+
MIRR (Modified Internal Rate of Return) corrects the main flaw of standard IRR: the assumption that all intermediate positive cash flows can be reinvested at the IRR itself. If your IRR is 35%, standard IRR assumes you can continuously reinvest each year's cash at 35% — which is almost never realistic. MIRR separates the reinvestment rate (what you can actually earn on reinvested cash, typically your WACC or a bond rate) from the finance rate (your cost of capital). Use MIRR when the IRR is substantially above your reinvestment opportunities, when comparing mutually exclusive projects of different scales, or when presenting returns to investors who understand its more conservative assumptions. For most corporate capital projects, MIRR and IRR are close enough that the difference is immaterial, but for high-return PE and venture investments, MIRR gives a meaningfully more conservative and accurate picture.
Why can IRR give a misleading answer?+
IRR has four known failure modes. First, the reinvestment rate assumption: as described above, it assumes reinvestment at the IRR rate, inflating returns for high-IRR projects. Second, multiple IRRs: when cash flows change sign more than once (positive, then negative due to decommissioning costs, then positive again), the polynomial equation can have multiple solutions — there is no unique IRR and the result is ambiguous. Third, scale blindness: a $10,000 investment at 50% IRR creates less absolute value than a $10 million investment at 20% IRR. IRR always favours smaller, higher-return investments regardless of value created. Fourth, it ignores absolute duration — a 5-year investment at 25% IRR may be inferior to a 20-year investment at 20% IRR if the longer compound period creates significantly more terminal wealth. Always use IRR alongside NPV and MOIC to get the complete picture.
What is the profitability index and how do I use it?+
The profitability index (PI) is the ratio of the present value of future cash flows to the initial investment. A PI of 1.0 means the NPV is exactly zero — the investment earns exactly the hurdle rate and neither creates nor destroys value. A PI above 1.0 means NPV is positive and the investment creates value. A PI below 1.0 means NPV is negative. For example, a PI of 1.35 means the present value of future cash flows is 35% greater than the cost of the investment at the given discount rate. The profitability index is particularly useful for capital rationing decisions where you must rank projects competing for limited capital. Ranking by PI (rather than NPV alone) prioritises projects that create the most value per dollar invested, which is optimal when capital is constrained.
What hurdle rate should I use?+
The hurdle rate should reflect your weighted average cost of capital (WACC) plus a risk premium appropriate to the specific investment. WACC blends the after-tax cost of debt and the cost of equity weighted by capital structure. A typical established business might have a WACC of 8 to 12%. Most companies then add 2 to 5 percentage points above WACC as a margin of safety for capital projects to account for estimation error and execution risk. For a startup or early-stage venture, 20 to 25% is common because cost of equity is higher and there is no cheap debt financing. Private equity funds typically use 8 to 10% as the preferred return (hurdle) before carried interest vests, though the actual IRR target is much higher. Use the hurdle rate consistently across all projects you are comparing, and resist the temptation to lower it to make a marginal project appear attractive.
What is MOIC and how does it work alongside IRR?+
MOIC (Multiple on Invested Capital), also called the equity multiple, is the total cash returned divided by the initial investment, without any time adjustment. A 3.0x MOIC means you received three dollars back for every dollar invested over the holding period. IRR and MOIC together tell the complete story of an investment. A 3.0x MOIC over 10 years is approximately 12% IRR. A 3.0x MOIC over 3 years is approximately 44% IRR. The same total return is radically different in annual percentage terms depending on holding period. Private equity firms always report both because investors care about both the rate of compounding and the absolute multiple achieved. A 25% IRR with a 2.0x MOIC is a 4-year hold; a 25% IRR with a 4.0x MOIC is an 8-year hold. Both have the same annual rate but very different terminal wealth outcomes and risk profiles.