What does Internal Rate of Return (IRR) & Extended IRR actually represent in finance?
In: Economics
So imagine you want to buy a garden hose.
There are many varieties of hoses, some with a half inch wide hole and 10 ft length. Some with quarter of an inch he and 20 ft length.
Given the standardized average pressure of water in your garden tap, if I give you a formula which calculates the farthest a garden hose can water your lawn while starting out from your doorstep – That would give you a good idea of which hose to buy.
That’s what IRR translates to in Real life.
XIRR works like this —
Imagine you finalized which hose to buy. Now your local municipality tells you that after one year, we’re gonna halve the pressure of water to your home. To compensate, you will make some adjustments, maybe cut the length of your pipes to ensure the pressure stays constant.
Or maybe 2 years after that, they say hey, we’re gonna quadruple the pressure of water. You may then want to invest in a stop cock or an extension hose to ensure you stay ahead of the curve in your annual lawn watering competition.
Thats what the IRR and XIRR would calculate – it being the average square area of lawn you would be able to water while standing on your doorstep in different scenarios and comparing products on that.
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