What is the Internal Rate of Return (IRR)?

Internal Rate of Return. The rate of return that would make the present value of future cash flows plus the final market value of an investment or business opportunity equal the current market price of the investment or opportunity. also called dollar-weighted rate of return.

Internal rate of return (IRR) is the interest rate at which the net present value of all the cash flows (both positive and negative) from a project or investment equal zero. Internal rate of return is used to evaluate the attractiveness of a project or investment. If the IRR of a new project exceeds a company’s required rate of return, that project is desirable. If IRR falls below the required rate of return, the project should be rejected. How it works/Example: The formula for IRR is:0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n where P0, P1, . . . Pn equals the cash flows in periods1,2, . . . n, respectively; and IRR equals the project's internal rate of return. Let's look at an example to illustrate how to use IRR. Assume Company XYZ must decide whether to purchase a piece of factory equipment for $300,000. The equipment would only last three years, but it is expected to generate $150,000 of additional annual profit during those years. Company XYZ also thinks it can sell the equipment for scrap afterward for about $10,000. Using IRR, Company XYZ can determine whether the equipment purchase is a better use of its cash than its other investment options, which should return about10%. Here is how the IRR equation looks in this scenario:0 = -$300,000 + ($150,000)/(1+.2431) + ($150,000)/(1+.2431)2 + ($150,000)/(1+.2431)3 + $10,000/(1+.2431)4 The investment's IRR is24.31%, which is the rate that makes the present value of the investment's cash flows equal to zero. From a purely financial standpoint, Company XYZ should purchase the equipment since this generates a24.31% return for the Company --much higher than the10% return available from other investments. A general rule of thumb is that the IRR value cannot be derived analytically. Instead, IRR must be found by using mathematical trial-and-error to derive the appropriate rate. However, most business calculators and spreadsheet programs will automatically perform this function. [Click here to see How to Calculate IRR Using a Financial Calculator or Microsoft Excel] IRR can also be used to calculate expected returns on stocks or investments, including the yield to maturity on bonds. IRR calculates the yield on an investment and is thus different than net present value (NPV) value of an investment. Why it Matters: IRR allows managers to rank projects by their overall rates of return rather than their net present values, and the investment with the highest IRR is usually preferred. Ease of comparison makes IRR attractive, but there are limits to its usefulness. For example, IRR works only for investments that have an initial cash outflow (the purchase of the investment) followed by one or more cash inflows. Also, IRR does not measure the absolute size of the investment or the return. This means that IRR can favor investments with high rates of return even if the dollar amount of the return is very small. For example, a $1 investment returning $3 will have a higher IRR than a $1 million investment returning $2 million. Another short-coming is that IRR can’t be used if the investment generates interim cash flows. Finally, IRR does not consider cost of capital and can’t compare projects with different durations. IRR is best-suited for analyzing venture capital and private equity investments, which typically entail multiple cash investments over the life of the business, and a single cash outflow at the end via IPO or sale.

en.wikipedia.org/wiki/Internal_rate_of_return

Definition . The internal rate of return on an investment or project is the "annualized effective compounded return rate" or rate of return that makes the net present 

The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return (DCFROR).[1] In the context of savings and loans, the IRR is also called the effective interest rate. The term internal refers to the fact that its calculation does not incorporate environmental factors (e.g., the interest rate or inflation).

In Summary : Internal Rate of Return is a financial metric for cash flow analysis, often used for evaluating investments, capital acquisitions, project and program proposals, and business case scenarios .

 

Internal Rate of Return. The rate of return that would make thepresent value of future cash flows plus the final market value of an investment or business opportunity equal the current market price of the investment or opportunity. also called dollar-weighted rate of return.

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The rate of return that would make the present value of future  cash flows plus the final market value of an investment or business opportunity equal the current market price of the investment or opportunity. The internal rate of return is an important calculation used frequently to determine if a given investment is worthwhile. An investment is generally considered worthwhile if the internal rate of return is greater than the return of an average similar investment opportunity, or if it is greater than the cost of capitall of the opportunity. also called  dollar-weighted rate of return. 

The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return (DCFROR). In the context of savings and loans, the IRR is also called the effective interest rate. The term internal refers to the fact that its calculation does not incorporate environmental factors (e.g., the interest rate or inflation).

The Mathematical Definition is

the discount rate that causes the net present value to equal zero

 

In General

is the average annual return earned through the life of an investment and is computed in several ways. Depending on the method used, it can either be the effective rate of interest on a deposit or loan, or the discount rate that reduces to zero the net present value of a stream of income inflows and outflows

   

it's to measure and compare the profitability of investments.

Agree with the answer provided by Experts. Thank You.

The internal rate of return (IRR) or economic rate of return  is a rate of return used in capital budgeting to measure and compare the profitability of investments