Quick Summary
IRR represents the expected compound annual rate of return on an investment.
Internal Rate of Return (IRR) is the discount rate at which the Net Present Value (NPV) of all cash flows (both positive and negative) from a project or investment equals zero. It represents the expected compound annual rate of return.
IRR Formula Concept
0 = Σ [Cash Flow_t / (1 + IRR)^t] - Initial Investment
IRR is the rate that satisfies this equation (typically found using iterative methods or Excel/Calculator).
Example
Investment: ₹100
- Year 1 inflow: ₹40
- Year 2 inflow: ₹50
- Year 3 inflow: ₹60
IRR ≈ 21.6% (the rate that makes NPV = 0)
Decision Rule
- IRR > Cost of Capital: Accept project
- IRR = Cost of Capital: Indifferent
- IRR < Cost of Capital: Reject project
IRR vs NPV
| IRR | NPV |
|---|---|
| Shows percentage return | Shows absolute value |
| Easier to communicate | More theoretically correct |
| May have multiple solutions | Always single answer |
Key Points
- Rate where NPV equals zero
- Represents expected annual return
- Compare to cost of capital
- Useful for go/no-go decisions
- May conflict with NPV in some cases