Calculate Real IRR by Deflating Cash Flows for Inflation

Summary

The document explains how to account for inflation when calculating an internal rate of return. Its method is to build a price index from the inflation rate, convert each cash flow into real terms by deflating it with the corresponding index, and then calculate IRR on the adjusted cash-flow series. This provides a real return measure rather than a nominal one; the response notes that even a constant inflation rate can affect the result when cash flows alternate between inflows and outflows.

An extreme illustrative example compares two alternating sequences with opposite starting signs. Although both have a nominal IRR of zero, deflation changes the real-term series differently, showing why the timing and sign of cash flows matter. The example is conceptual rather than a worked spreadsheet formula. The answer assumes that a suitable inflation price series can be constructed and does not explain how to handle varying rates, index timing, or multiple IRRs from non-conventional cash flows.

Key ideas

• Build a price index from inflation rates to convert nominal cash flows into real terms.
• Deflate each cash flow using the price index before calculating IRR.
• A constant inflation rate can still affect real returns when cash flows alternate in sign.
• Sequences with opposite starting signs can share a nominal IRR yet differ after deflation.
• The response does not give spreadsheet steps or address multiple-IRR cases.

Tags

# IRR with Inflation Rate


# IRR with Inflation Rate












I have cash inflows and cash outflows for a 7 year period and my MIRR and inflation rate. That's all the information I have.

How do I calculation the IRR taking the inflation rate into account in Excel ?

## Answer by demully (score 1)

https://quant.stackexchange.com/a/60566

OK, you need to create a price series based on your "inflation" rate. Deflate all your cashflows by this, to give you a series of real cashflows. And then you can do a normal IRR calculation, based on these real cashflows.

Even if your inflation rate is constant rather than time-varying, this can make a difference. Imagine a series of cashflows that goes -100, +100, -100, +100 ad infinitum, versus the opposite that does +100, -100, +100, -100 ad infinitum. IRR'ing these will give you the same nominal 0% IRR. Subtracting any constant inflation rate will thus give you the same real returns. Except if inflation is running at, say, 100% a year, the real returns will be VERY different ;-)

So this would in reality become:

-100, +50, -25, +12.5, -6.25...

against

+100, -50, +25, -12.5, +6.25...

Not the same thing at all. Obviously, an extreme example. But hopefully the point is obvious. Just discount all the cashflows by your inflation price series, to give you a real-terms IRR.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.