Real-world examples of internal rate of return (IRR) explained clearly

Why start with examples of internal rate of return (IRR)?

Internal rate of return is one of those metrics that sounds fancy but is really just answering one question:

“What annual return would make the present value of all cash inflows equal to the initial investment?”

That’s it. When we walk through real numbers, IRR stops being mysterious. So instead of definitions, we’ll build understanding through examples of internal rate of return (IRR) explained in different contexts:

• A simple one-year project vs. a multi-year project
• A rental property with uneven cash flows
• A startup marketing campaign with uncertain payoffs
• A solar panel installation with tax benefits
• A private equity-style deal with a big exit
• A project with negative cash flows in the middle (the IRR trap)

Along the way, we’ll connect these examples to how analysts actually make decisions in 2024–2025, when interest rates and risk-free yields are much higher than they were a few years ago.

A simple example of IRR: two projects with the same total profit

Imagine a company choosing between Project A and Project B. Each requires a \(10,000 investment today. Both return \)15,000 total, but with different timing.

• Project A: Pay \(10,000 now, receive \)15,000 in one year
• Project B: Pay \(10,000 now, receive \)5,000 each year for three years

The total profit is $5,000 in both cases, but the timing is very different.

If you compute the IRR (using a financial calculator or Excel/Google Sheets =IRR()):

• Project A IRR ≈ 50%
• Project B IRR ≈ 23.4%

This is one of the best examples of how IRR rewards speed of payback. Even though both projects earn the same total dollars, the project that returns money faster has a much higher internal rate of return.

In 2024–2025, when U.S. Treasury yields are often in the 4–5% range depending on maturity (you can see current data at the U.S. Treasury site: https://home.treasury.gov), both IRRs look attractive. But if capital is scarce, Project A looks dramatically better because it returns cash much sooner.

Rental property: examples of internal rate of return (IRR) explained with uneven cash flows

Real estate is a classic place where investors rely on IRR, because cash flows are rarely smooth.

Imagine you buy a small rental property for $300,000 with the following assumptions:

• You pay $60,000 down and finance the rest with a mortgage
• Net cash flow after mortgage, taxes, and maintenance starts at $3,000 in year 1 and grows by about 3% per year
• You plan to sell in year 10 for $420,000 (after selling costs)

The cash flow from your perspective (equity investor) might look like this:

• Year 0: –$60,000 (down payment, closing costs)
• Year 1: +$3,000
• Year 2: +$3,090
• Year 3: +$3,183
• Year 4: +$3,278
• Year 5: +$3,376
• Year 6: +$3,477
• Year 7: +$3,581
• Year 8: +$3,688
• Year 9: +$3,799
• Year 10: +\(3,913 + \)420,000 (rental income plus sale net of remaining mortgage)

Using these cash flows, the IRR is roughly 13–15%, depending on the exact mortgage details.

This rental property is one of the best real examples of internal rate of return (IRR) explained in practice:

• It’s not a neat, single cash flow in and out
• There’s a mix of ongoing income and a big terminal value at the end
• IRR captures the combined effect of rent growth, leverage, and the sale price

In 2024–2025, with mortgage rates still relatively elevated compared with the 2010s (see data from the Federal Reserve at https://fred.stlouisfed.org), investors often compare this kind of 13–15% IRR to the risk and hassle of being a landlord. IRR doesn’t make the decision for you, but it gives a clean annualized return to compare against alternatives.

Startup marketing campaign: a fast-payback example of IRR

Now consider a tech startup deciding whether to spend $200,000 on a targeted online marketing campaign.

The marketing team projects this cash flow impact:

• Year 0: –$200,000 (campaign cost)
• Year 1: +$120,000 (net additional profit from new customers)
• Year 2: +$120,000
• Year 3: +$80,000 (effect tapers off)

If we run an IRR calculation on these cash flows, we get an IRR of roughly 42–45%.

This example of internal rate of return (IRR) is powerful for decision-making:

• A 42–45% IRR looks attractive when your cost of capital is, say, 12–15%
• The company can compare this IRR to other uses of capital like product development or hiring

But here’s where real examples include some nuance:

• The cash flows are projections, not guaranteed
• If customer churn is worse than expected, the actual IRR could be much lower

So while IRR gives a clean number, savvy managers still run sensitivity analyses—varying assumptions to see how IRR changes if revenue comes in 20% lower or costs come in 20% higher.

Solar panels for a business: examples of IRR with tax credits

Energy projects are another space where IRR is heavily used, especially with incentives and tax rules changing over time.

Imagine a small manufacturing firm in the U.S. considering a solar panel installation on its roof in 2024.

• Upfront cost: $500,000
• Federal tax credit (Investment Tax Credit, ITC): 30% of cost (subject to current law; see details at the U.S. Department of Energy: https://www.energy.gov)
• Annual electricity savings: $70,000 in year 1, growing 2% annually
• System life: 25 years

Simplifying a bit, the effective initial outlay after the tax credit is:

• Year 0: –$350,000 (net of the 30% credit)

Then the cash flows from savings might look like:

• Year 1: +$70,000
• Year 2: +$71,400
• …
• Year 25: last year of savings, then system is effectively worn out

Using these cash flows and ignoring minor items like maintenance for clarity, the IRR might land around 15–18%.

This is one of the more realistic examples of internal rate of return (IRR) explained for 2024–2025:

• The IRR depends heavily on policy (tax credits, local incentives)
• If the tax credit is reduced or removed, the IRR can drop sharply

Energy companies and corporate finance teams use IRR to compare solar, efficiency upgrades, and other capital projects against their weighted average cost of capital and against simply paying down debt.

Private equity–style deal: big exit, no cash until the end

Now let’s look at a private equity–style investment, where most of the payoff comes from a sale at the end.

You invest $1,000,000 in a private company. The plan:

• No dividends or distributions for the first 4 years
• In year 5, sell your stake for $2,000,000

Cash flows:

• Year 0: –$1,000,000
• Year 1: $0
• Year 2: $0
• Year 3: $0
• Year 4: $0
• Year 5: +$2,000,000

The IRR on this investment is about 14.9%.

Now compare that to a slightly different real example of internal rate of return:

• Year 0: –$1,000,000
• Year 2: +$200,000
• Year 5: +$1,800,000

Total payoff is the same \(2,000,000, but you get \)200,000 earlier. The IRR now rises to roughly 16.5%.

These examples include a key lesson: timing matters more than most people intuitively expect. In private equity, venture capital, and startup investing, IRR is a favored metric precisely because it rewards getting cash back sooner, not just getting more cash back.

The IRR trap: multiple sign changes and misleading results

So far, our examples of internal rate of return (IRR) explained have had a single big outflow followed by inflows. Real life can be messier.

Consider a mining project:

• Year 0: –$50 million (build the mine)
• Years 1–4: strong profits
• Year 5: –$20 million (environmental cleanup or expansion)
• Years 6–10: more profits

This pattern has multiple sign changes (negative → positive → negative → positive). That opens the door to multiple IRRs, which is a known mathematical quirk.

For a simplified version:

• Year 0: –$100
• Year 1: +$230
• Year 2: –$132

If you solve for IRR, you can get two valid IRR values that satisfy the math. That’s not just a theoretical oddity; it’s why many analysts prefer net present value (NPV) with a chosen discount rate when cash flows flip signs more than once.

A good example of internal rate of return (IRR) being misused is when managers ignore this issue and present a single IRR for a project with complex cash flows. In those cases, NPV is often more reliable, and IRR should be treated carefully.

For a deeper mathematical discussion of IRR and NPV, finance and economics courses from universities like MIT and Harvard (e.g., https://ocw.mit.edu or https://online.hbs.edu) often include lecture notes and problem sets you can explore.

How to interpret IRR in 2024–2025

IRR isn’t just a theoretical number; it lives in a real interest rate environment. In 2024–2025:

• Risk-free rates (like U.S. Treasuries) are higher than they were in the 2010s
• Corporate borrowing costs are also higher
• Investors demand higher returns for risky projects to compensate

That changes how we read the examples of internal rate of return (IRR) explained above:

• A 5–6% IRR might have looked okay when 10-year Treasuries yielded 1–2%; now it often looks weak
• A 12–15% IRR can still be attractive, but only if the risk profile is reasonable
• A 30–40% IRR on a marketing campaign or startup project sounds great, but you need to check whether the assumptions are realistic

In other words, IRR is always relative to:

• Your cost of capital
• The risk-free rate
• The riskiness of the specific project

You can think of IRR as a way to put your project side-by-side with alternatives like:

• Paying down debt
• Returning cash to shareholders
• Investing in safer bonds or index funds

Common mistakes when using IRR (with real examples)

To make these examples of internal rate of return (IRR) explained truly useful, it helps to highlight where people routinely go wrong.

1. Ignoring project scale
Example: A project with a 40% IRR on a \(10,000 investment vs. a 20% IRR on a \)10 million investment. The smaller project has a higher IRR, but the larger project creates far more total value. That’s why professionals often look at both IRR and NPV.

2. Comparing IRRs across very different risk levels
Example: A government-backed infrastructure bond with a 7% IRR versus a speculative crypto mining project with a 25% IRR. The higher IRR doesn’t automatically make the second project better; it may simply reflect higher risk.

3. Assuming reinvestment at the IRR
The classic textbook assumption is that interim cash flows are reinvested at the IRR itself. In a 2024 environment, reinvesting at 40% annually is rarely realistic. Some analysts use modified internal rate of return (MIRR) to address this.

4. Using IRR instead of thinking about liquidity
A private investment with a 20% IRR but no cash flows for 10 years ties up capital. A lower-IRR project that returns cash sooner might be more attractive if you value flexibility.

These real examples include the context that textbooks often skip: IRR is a tool, not a verdict.

FAQ: examples of internal rate of return (IRR) in practice

Q1. Can you give a simple example of internal rate of return (IRR) for a small business?
Yes. Imagine a small bakery spends \(50,000 on new ovens. The new equipment is expected to increase annual profit by \)15,000 for 5 years. Cash flows:

• Year 0: –$50,000
• Years 1–5: +$15,000 each year

The IRR here is around 19–20%. The owner can compare this to borrowing costs and other investment options to decide if the upgrade makes sense.

Q2. What are some of the best examples of IRR used in personal finance?
Common personal finance examples include:

• Buying a rental property and using IRR to measure your return on equity
• Evaluating a college degree as an investment: tuition outflows now, higher earnings later (organizations like the Georgetown University Center on Education and the Workforce, https://cew.georgetown.edu, publish data that can feed into these models)
• Comparing solar panels or home efficiency upgrades to simply investing in index funds

In all of these, you’re looking at cash out today versus cash in later, exactly what internal rate of return is designed to summarize.

Q3. Are there examples of IRR being misleading?
Yes. A classic misleading example of IRR is a project with multiple sign changes in cash flow, which can produce more than one IRR. Another is a small high-IRR project compared with a large moderate-IRR project: the small project “wins” on IRR but creates far less total value. That’s why professionals always pair IRR with NPV and a sense of scale.

Q4. How does IRR compare to average annual return?
IRR accounts for when cash flows occur, not just how much. If you invest \(10,000 and receive \)15,000 after one year, your IRR and your average annual return are both 50%. But if you receive \(5,000 per year over three years, your total profit is still \)5,000, yet your IRR drops to about 23.4% because the cash comes in more slowly. That timing sensitivity is what makes these examples of internal rate of return (IRR) explained so useful.

Q5. Where can I learn more about IRR and related concepts?
Many university finance courses and open educational resources walk through theory and problem sets. For structured learning, you can explore:

• MIT OpenCourseWare finance materials: https://ocw.mit.edu
• Harvard Business School Online finance courses: https://online.hbs.edu

These sources provide more formal derivations, while the real examples in this article show how IRR plays out in day-to-day decision-making.

The bottom line: the best examples of internal rate of return (IRR) explained are not abstract. They’re tied to decisions you actually face—whether to buy that property, fund that project, or back that startup. Once you start thinking in terms of cash in, cash out, and timing, IRR becomes less of a formula and more of a practical, everyday tool.