IRR Calculator UK

What Is IRR (Internal Rate of Return)?

The Internal Rate of Return (IRR) is one of the most widely used metrics in investment appraisal and capital budgeting. It represents the discount rate at which the Net Present Value (NPV) of an investment's future cash flows equals zero. In practical terms, IRR tells you the annualised percentage return you can expect from an investment if all projected cash flows are realised.

UK businesses, private equity firms, property investors, and project finance teams use IRR as a key decision-making criterion. When IRR is compared against the company's Weighted Average Cost of Capital (WACC) or a specified hurdle rate, it provides a clear binary decision: if IRR exceeds the hurdle rate, the investment is expected to create value and should be accepted; if IRR falls below the hurdle rate, the investment should be rejected.

How to Calculate IRR

IRR cannot be calculated with a simple formula; it requires an iterative numerical method. Our calculator uses the Newton-Raphson algorithm, which is the same approach used in Excel's IRR function. The algorithm works by starting with an initial guess for the IRR, then progressively refining that guess until the NPV of the cash flow series is driven to zero (or as close to zero as mathematically possible).

To calculate IRR using our tool, you need to enter:

• Initial investment: The amount invested at time zero (Year 0), entered as a positive number. The calculator treats this as a negative cash flow.
• Annual cash flows: The projected net cash inflows for each year of the investment, entered as positive values. Enter years sequentially; blank fields are treated as the end of the investment period.
• WACC / hurdle rate: Your company's cost of capital or the minimum acceptable rate of return, used to calculate NPV and render the accept/reject decision.

IRR vs NPV: Which Should You Use?

Both IRR and NPV are discounted cash flow (DCF) analysis techniques and are closely related. In most cases, they give the same accept/reject signal: a positive NPV corresponds to an IRR above the discount rate, and vice versa. However, there are situations where the two methods conflict:

• Scale differences: IRR ignores the scale of an investment. A £10,000 project returning 40% IRR creates less absolute value than a £1 million project at 20% IRR. NPV, by giving a result in pounds, makes scale obvious.
• Mutually exclusive projects: When choosing between two projects where only one can be selected, NPV is generally the better metric because it reflects the absolute value created.
• Non-conventional cash flows: If a project has multiple sign changes in its cash flows (for example, large costs in the middle of the project), there may be multiple IRR values, making IRR unreliable. NPV is always unambiguous.
• Reinvestment assumption: IRR implicitly assumes that intermediate cash flows are reinvested at the IRR itself, which may be unrealistically optimistic. NPV assumes reinvestment at the discount rate (WACC), which is generally more realistic.

For most straightforward investment decisions, IRR and NPV will agree. For more complex analyses, especially with large sums or mutually exclusive projects, rely more heavily on NPV.

What Is a Good IRR for UK Investments?

There is no universal answer, as the appropriate IRR depends entirely on the risk profile, industry, and the investor's alternative opportunities. General benchmarks for UK investment categories in 2025 include:

• Government bonds (gilts): 4-5% (essentially risk-free, sets the floor)
• UK residential property: 6-12% depending on location and leverage
• UK commercial property: 7-14%
• UK listed equities (FTSE All-Share historical average): approximately 8-10% total return
• Corporate capital expenditure projects: typically require IRR of WACC + 3-5% buffer
• Private equity: typically targets IRR of 20-30%
• Venture capital: targets IRR of 30% or more to compensate for higher failure rates
• Infrastructure projects: 8-13% depending on concession terms and risk profile

Understanding the Payback Period

The payback period is the length of time required to recover the initial investment from the cumulative undiscounted cash flows. It is one of the simplest investment appraisal tools and is particularly useful as a measure of liquidity risk: the shorter the payback period, the sooner the investor recovers their capital and the lower the risk of loss.

However, the payback period has two significant weaknesses: it ignores the time value of money (a pound received in Year 5 is counted equally to one received in Year 1) and it ignores cash flows beyond the payback point. A project with a 3-year payback but only modest subsequent returns might be far less attractive than one with a 4-year payback but very large returns in Years 5-10. This is why payback should always be used alongside IRR and NPV rather than in isolation.

WACC and the Hurdle Rate

The Weighted Average Cost of Capital (WACC) represents the minimum return an investment must earn to satisfy all of a company's capital providers. It blends the cost of equity (what shareholders require) and the cost of debt (the interest rate on borrowing) in proportion to how each is used in the capital structure. For a UK company with £7 million in equity costing 12% and £3 million in debt at 6% (post-tax), the WACC would be approximately 10.2%.

Many companies add a risk premium to WACC to create a hurdle rate, particularly for riskier or more speculative projects. If a company's WACC is 10%, it might apply a hurdle rate of 13-15% to projects in new markets or involving unproven technology, while accepting a lower hurdle rate of 10-11% for routine capital maintenance projects in established operations.

IRR in UK Property Investment

IRR is increasingly used by UK property investors, both commercial and residential, as a sophisticated alternative to simple yield calculations. A buy-to-let investor might assess a property by projecting rental income, net of costs and voids, alongside the eventual sale proceeds. By running these cash flows through an IRR calculation, they can compare the return with alternative investments on a like-for-like basis.

For commercial property, IRR analysis typically considers a 10-year hold period, incorporating projected rental growth, re-letting costs during void periods, capital expenditure for refurbishment, and an exit yield assumption at Year 10. HMRC taxation on capital gains and rental income must be accounted for to arrive at the true after-tax IRR.

Frequently Asked Questions