Calculating and Estimating Internal Rate of Return
Whats the best way to do an IRR calc in your head? is there a simple calculation and relationship when you think about initial investment, sale price and time period? just for back of envelope calcs when youre sitting in a meeting or an interview.
How To Calculate Internal Rate of Return
The following is a brief refresher on IRR.
From the Wall Street Oasis Finance Dictionary
Internal Rate of Return or IRR is a financial metric used to discount capital budgeting and to make the net present value of all future cash flows equal to zero. For this reason, it is used alongside a Discounted Cash Flow analysis.
Calculating IRR cannot be calculated by hand unless you use a trial and error method to until you reach a solution in which net present value equals zero. Otherwise, you will need a special calculator or a program like Microsoft Excel. However, you can estimate IRR by memorizing simplified outputs of an IRR table.
How to Estimate IRR
The following is an introduction to estimating IRR by certified user @Marcus_Halberstram", an industry CEO. Once you understand the concept you can memorize the internal rate of return table below. Then you will be able to estimate IRR off of the top of your head!
The best way to approximate IRR is by memorizing simple IRRs.
- Double your money in 1 year, IRR = 100%
- Double your money in 2 years, IRR = 41%; about 40%
- Double your money in 3 years, IRR = 26%; about 25%
- Double your money in 4 years, IRR = 19%; about 20%
- Double your money in 5 years, IRR = 15%; about 15%
That's really all you need to know. So if you 1.5x you money in 2 years, you know that if you double your money in 2 years its a 40% return and if you only get your initial investment after 2 years, its a 0% return... mid-point of 0% and 40% is 20%... so your IRR is roughly 20%... now take into account that the 0% return scenario doesn't include any compounding... so you need to upwardly adjust that 20% figure... so make it 21 or 22%. Just did the IRR calc, what does it come out to? 22%.
No one expects you to be able to nail an IRR number in your head. But if you can get pretty close, you're fine.
- X Axis: Number of Years
- Y Axis: Multiple
|1 Year||2 Years||3 Years||4 Years||5 Years|
View the full table at http://willprice.blogspot.com/2007/06/irr-multiplication-table.html
- Unlevered and Levered IRR for Real Estate
- Relationship Between Cap Rate Discount Rate and NPV
- What is Internal Rate of Return?
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