Excel IRR function - clueless and questions about the GUESS argument

Posted on 2016-07-21
Medium Priority
Last Modified: 2016-08-19
the IRR function makes sense when you take a calculation like:
-1,200 - cash outlay for a new ice cream machine.
+ 500 year one cash flow
+300 Year two cash flow
+400 Year three cash flow
+400 Year four cash flow
Okay.  So why use the GUESS argument when I successfully figured out the IRR above without using GUESS?
I'm trying to understand why you would use guess.  Perhaps a couple examples of when to NOT use and when TO use GUESS?

I googled this and came up with some fairly erudite math explanations but I'm not a math major .  So, please
Question by:brothertruffle880
1 Comment
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Accepted Solution

wsh2 earned 2000 total points
ID: 41723823
The results of an IRR calculation are gotten through extrapolation.

The way it works, the formula guesses an interest rate, does the calculation and comes up with a result. If the result is not equal to zero, the formula adjusts the guesstimated interest rate up if the calculated result is negative, or down if the calculated result is positive. Using these over/under adjustments the formula keeps calculating until the result is equal to 0 and returns that interest rate as the IRR.

It is a guessing game. Just like playing "am I hot" or "am I cold" as a child. The closer you got to the secret object the hotter you were. The further away, the colder you were.

The purpose of the "Guess" is to give the formula a bit of a head start so that it doesn't have to iterate through all numbers between 1 and 1,000,000, which can be a very timely process.  The "Guess" localizes the number into a smaller range and aas a result the number of calculations needed to be done are fewer.

Using our "am I hot" or "am I cold" game as an example again, let's say the playing field is the whole house. To search the whole house for the secret object may take a bit of time. However, if someone were to give you a hint that the secret object MAY be in the kitchen just imagine how much time this would save in the search process.

Long story short, all the IRR "Guess" is is a hint where you may find the correct IRR result. The better the "Guess" (hint) the quicker you may find the "secret object".

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