IRR vs CAGR
IRR or internal rate of return is a return earned on a project over its life. It considers all the cashflows be it inflows or outflows. IRR basically calculates the % return on an investment.
Whereas CAGR is simply used to calculate the growth in cashflows. it only considers first and last cashflows doesn’t considers cashflows in-between.
Example:
A company invested 100000 in a project, which will provide following cashflows to the company.
year 1 : 5000
year 2 : 10000
year 3 : 30000
year 4 : 15000
year 5 : 50000
total = 110000
to find the Return on the investment we can just do the following;
R = (110000-100000)/100000 = 10%
But the problem is that this return doesn’t consider the time value of money here IRR comes into play. to calculate IRR we can simply use IRR function of excel.
function is given as follows
= IRR(value1, value2,value3….)
value1 will be negative as this will represent the investment other values will be the returns from the project.
so we have
=IRR(-100000,5000,10000,30000,15000,50000)
the IRR = 2.51%
Now this company wants to find the growth in its earnings, it has following earnings
year 1,2,3,4
earnings 1000,3000,5000,7000
Growth = CAGR = (7000/1000)^(1/(4-1) -1 = 91.29%