In a capital improvement project, you invest an initial payment to receive a series of cash flows over the project's lifetime. For the project to be profitable, these flows must exceed the investment. Yet profitability must also take into account how a future dollar is worth less to you than a dollar now. The project's internal rate of return is the compounded discount rate at which the project's total cash flows equal the initial investment. You cannot calculate this rate using direct mathematics, but you can using a financial calculator.
1. Open an internal rate of return calculator, such as the one listed under "Resources."
2. Enter the initial investment, preceded by a negative sign, as the first cash flow payment. For example, if your initial investment is $5,000, type "-5000" into the cash flow text box.
3. Enter each year's successive cash flow on the lines below the initial investment. For example, suppose that your investment brings cash flows of $1,350, $1,450, $1,560 and $2,000 at the end of the following four years. Enter "1350," "1450," "1560" and "2000" on successive lines.
4. Choose "Yearly" under "Payment period interval" if these cash flows represent successive years. Other options for period intervals may include "monthly" and "quarterly."
5. Click the "calculate" button. With this example, the internal rate of return is 9.685 percent.
- There are also computer programs, such as spreadsheets, that you can use to calculate the internal rate of return
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