Internal Rate of Return

Knowledge Center

12manage is looking for students. Info

Calculation of the true interest yield expected from an investment. Explanation of Internal Rate of Return.

What is Internal Rate of Return? Definition

The Internal Rate of Return (IRR) is the discount rate that delivers a net present value of zero for a series of future cash flows. It is an Discounted Cash Flow (DCF) approach to valuation and investing. As is Net Present Value (NPV). IRR and NPV are widely used to decide which investments should be undertaken, and which investments not to make.

Difference of IRR and NPV

The major difference is that while Net Present Value is expressed in monetary units (Euro's or Dollars for example), the IRR is the true interest yield expected from an investment expressed as a percentage. 

Internal Rate of Return is the flip side of Net Present Value and is based on the same principles and the same calculations. NPV shows the value of a stream of future cash flows discounted back to the present by some percentage that represents the minimum desired rate of return, often your company's cost of capital. IRR, on the other hand, computes a break-even rate of return. It shows the discount rate below which an investment causes a positive NPV (and should be made). And above which an investment causes a negative NPV (and should be avoided). It's the break-even discount rate, the rate at which the value of cash outflows equals the value of cash inflows.

Many people find the percentages of IRR easier to understand than Net Present Value. Another benefit from IRR is that it can be calculated without having to estimate the (absolute) cost of capital.

The IRR approach

When IRR is used, the usual approach is to select the projects whose IRR exceeds the cost of capital (often called hurdle rate when used in the IRR context). This may seem simple and straightforward at first sight. However a major disadvantage of using the Internal Rate of Return instead of Net Present Value is that if managers focus on maximizing IRR and not NPV, there is a significant risk in companies where the return on investment is greater than the Weighted Average Cost of Capital (WACC): that managers will not invest in projects that are expected to earn more than the WACC, but less than the return on existing assets. IRR is a true indication of a project's annual return of investment only when the project generates no interim cash flows - or when those interim investments can be invested at the actual IRR.

The aim of the value-oriented manager should be to invest in any project that has a positive NPV! If IRR usage is unavoidable, then managers are advised to use so called Modified IRR (which, while not perfect, at least allows to set more realistic interim reinvestment rates) and additionally to keep a close look on interim cash-flows, especially if they are biased to the beginning of the project period (the distortion is bigger then).

In other words: the aim should not be to maximize the Internal Rate of Return, but to maximize Net Present Value.

Book: Aswath Damodaran - Investment Valuation: Tools and Techniques for Determining the Value.. -

Book: James R. Hitchner - Financial Valuation: Applications and Models -

Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -

Special Interest Group - Internal Rate of Return

Special Interest Group (51 members)

Forum - Internal Rate of Return  

In this forum you will find recent interesting discussions.

  Internal Rate of Return (IRR) versus ROE versus ROA (1 reactions)
How can we explain that IRR is different from Return on Equi...
  Calculating Internal Rate of Return (2 reactions)
A project has an initial outlay of $4000. It has a single pa...
  Flat Rate versus Internal Rate of Return (IRR)
In Financial Budgeting & Planning, what is Internal Rate of ...
  Calculating the Rate of Return (2 reactions)
A leading broker has advertised money multiplier certificate...
  TVM versus Internal Rate of Return (IRR)
I seem to get different return or interest rates when using ...
  Internal Rate of Return and Real Estate (1 reactions)
As an example if an owner puts up $7,500,000 equity to buy a...
  Internal Rate of Return (IRR) Based KPIs
Given that IRR and NPV methods are about making decisions ab...
  Internal Rate of Return (IRR) in Real Value?
How to calculate IRR when cash flows are in real value?? Can...
Hot Advantages of Internal Rate of Return (IRR) Method
What are the main advantages of using Internal Rate of Retur...

Best Practices - Internal Rate of Return

Here you will find the most valuable discussions from the past.

  Internal Rate of Return (IRR) Formula (2 reactions)
Who can supply the exact mathematical formula of internal ra...
  Weaknesses of Internal Rate of Return (IRR) (3 reactions)
The primary weaknesses of this method are: - IIR sometimes ...

Expert Tips - Internal Rate of Return

Here you will find high-quality advice from experts.


Sensitivity Analysis

Define Minimum or Maximum Margins of the IRR...

Resources - Internal Rate of Return

Here you will find powerpoint presentations, micro-learning videos and further information sources.

Why Managers prefer IRR

Capital Budgeting...

Analyzing Financial Feasibility

Financial Feasibility Analysis, Project Selection, ROI, NPV, IRR...

Capital Budgeting

Calculate NPV, IRR, ROC...


Investment Appraisal...

News about Irr Npv


News about Modified Irr


Videos about Irr Npv


Videos about Modified Irr


Presentations about Irr Npv


Presentations about Modified Irr


Books about Irr Npv


Books about Modified Irr


More about Irr Npv


More about Modified Irr


Compare with: Net Present Value

Return to Management Hub: Decision-making & Valuation  |   Finance & Investing

More Management Methods, Models and Theory

Special Interest Group Leader

You here? Sign up for free


About 12manage | Advertising | Link to us / Cite us | Privacy | Suggestions | Terms of Service
© 2019 12manage - The Executive Fast Track. V15.1 - Last updated: 19-10-2019. All names ™ of their owners.