How do you calculate the internal rate of return on an investment when the cash flows vary and you can’t use a typical financial calculator that only functions with the same stream of payments, not a varying stream?
For example, you invest in an oil well where you contribute $100,000 the first year and the second year there is a $20,000 capital call (meaning you contribute $20,000 more).
Then in the third year, there wasn’t any income but starting in the fourth year, you received the following stream, $30,000, $25,000, $30,000, $28,000 and on down and then in the 14th year you got your last payment of $4000. For this example we are ignoring any tax implications on the contribution and on the income.
What is the annual internal rate of return? It is 8.57% as calculated below on the IRR calculator available at www.truthconcepts.com
How is the calculator figuring out the 8.57% return? It’s taking the investment of what you put up front, and getting the income stream back out as listed, and then figuring out that the account would have to earn the 8.57% every year in order to generate that stream of income and end up with zero at the end of the 14th year.
Anyone is welcome to buy this software if this type of calculation is something that they would use in their own personal situation or for any type of work they may do. Internal Rate of Return Calculations are helpful for figuring out IRR’s on oil and gas deals as above, life insurance policies, real estate deals and other investments where the money in and/or the money out is an uneven dollar figure every year.