Internal Rate of Return

Investments

Quick Definition

Internal Rate of Return (IRR) is the discount rate at which the net present value (NPV) of all cash flows from an investment becomes zero.

Detailed Explanation

IRR is a widely used metric to evaluate the profitability of investments or projects. It represents the expected annual rate of return that an investment will generate over time.

If the IRR is higher than the cost of capital, the investment is generally considered worthwhile.

Key Concept

👉 IRR is the rate where:
NPV = 0

Why IRR Matters

  • Helps compare different investment options
  • Used in capital budgeting decisions
  • Indicates efficiency of investment

Interpretation

  • IRR > Required Rate: Accept investment
  • IRR < Required Rate: Reject investment

Advantages

  • Considers time value of money
  • Easy to compare projects

Limitations

  • Can give multiple values (in some cases)
  • Assumes reinvestment at same rate

Example

"An investment of ₹1 lakh generates returns over 5 years. If IRR is 12%: 👉 It means the investment yields ~12% annual return"

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