10.4 Internal Rate of Return (IRR)

  1. LG4

The internal rate of return (IRR) is the discount rate that makes the NPV of an investment opportunity equal to $0. In other words, the IRR is the discount rate that equates the present value of a project’s cash inflows to the present value of its cash outflows. The IRR has another interpretation, similar to the yield to maturity (YTM) on a bond. The IRR is the average annual compound rate of return that a company earns on an investment project, assuming that project inflows and outflows occur as projected. Mathematically, the IRR is the value of r in Equation 10.1 that causes the NPV to equal $0. Replacing r in Equation 10.1 with IRR, we have

$0=t=1nCFt(1+IRR)tCF0(10.3)

Or, recognizing that projects ...

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