IRR Calculation
This article explains how internal rate of return (IRR) is calculated in Model Reef.
You will learn:
The difference between project IRR and equity IRR.
How IRR is computed from model cashflows.
How entry price or initial investment is handled.
IRR is the discount rate that makes the NPV of a series of cashflows equal to zero.
Cashflows used for IRR
Model Reef can compute IRR on two main cashflow sets:
Project IRR
Uses FCFF and any initial project investment.
Measures return to the full capital structure.
Equity IRR
Uses FCFE and equity entries and exits.
Measures return to equity holders only.
You can configure which cashflows are used for each IRR calculation in the valuation settings.
Role of purchase price or initial investment
To compute IRR, you usually need an initial negative cashflow that represents:
The price paid to acquire a business.
The equity invested at the start of a project.
The net initial funding requirement.
In Model Reef you can:
Enter a purchase price or initial equity investment as an input.
Combine this with future FCFF or FCFE cashflows.
The IRR is then the rate r that solves:
NPV
= Sum of (Cashflow in period ÷ (1 + r) ^ t)
= 0Where the first major cashflow is negative and later cashflows are positive in a typical investment case.
Numerical method and behaviour
The valuation engine uses numerical root finding similar to Excel's XIRR:
It handles uneven cashflow timing.
It works with varying period lengths.
It returns the rate that sets NPV to zero, if a solution exists.
In cases where cashflows change sign multiple times there may be multiple IRRs or none. In practice, most planning and transaction models use patterns with a single sign change, which produce a single economically meaningful IRR.
Interpreting IRR in scenarios
You can use IRR across scenarios to:
Compare Base, Downside and Upside equity returns.
See the impact of different capital structures or purchase prices.
Evaluate whether IRR meets internal or investor hurdles.
IRR should be interpreted together with NPV, money multiple and risk assumptions rather than in isolation.
Related articles
Last updated