Calculating IRR in R

Calculation of IRR in R is easy with the package called jrvFinance. You can install this package with the command install.packages("jrvFinance").

Why do we need to calculate the IRR or Internal rate of returns?

Let us suppose a manager has an opportunity to invest in two projects, but can only choose one project. The projects are:

Project 1 requires $800 million in investment today, but it will pay 200,250,300,350,400 million in payments each year for the next 5 years.

Project 2 required $500 million in investment today, but it will pay 150,170,178,250,300 in payments each year for the next 5 years.

How would the manager decide which project to choose? To solve this problem we need to calculate the IRR of the two projects. We show the solution below.

library(jrvFinance) # This package has a the irr formula to solve our problem
library(tidyquant) # general R quant package 
library(DT) # package to display pretty Data tables

project1_cf <- tibble(Year = 0:5,
             cf = c(-800,200,250,300,350,400))

project2_cf <- tibble(Year = 0:5,
             cf = c(-500,150,170,178,250,300))

project1_cf %>%
  DT::datatable(rownames = FALSE,caption = "Project 1")

project2_cf  %>%
  DT::datatable(rownames = FALSE,caption = "Project 2")

# To calculate IRR we will use the IRR formula from the jrvFinance library

irr1 <- project1_cf %>%
  select(cf) %>%
  .[[1]] %>%
  irr()


irr2 <- project2_cf %>%
  select(cf) %>%
  .[[1]] %>%
  irr()

irr_tbl <- tibble(Name = c("Project 1", "Project 2"),
                  IRR = c(irr1,irr2))

irr_tbl %>%
  datatable(caption = "Internal rate of returns for the two projects.")

From the above table we can see that project 1 has an IRR of 22.1603098 and project 2 has an IRR of 26.7619869. Even though project 1 offers higher cash flows, project 1 has a lower internal rate of returns. If the managers goal is to choose the project that maximizes profitability then he/she should choose project 2.