Principles of Managerial Finance, 15th Edition

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

$$\text{\$}0={\displaystyle \sum _{t=1}^n}{\displaystyle \frac{C{F}_t}{{\left(1+IRR\right)}^t}}-C{F}_0$$(10.3)

Or, recognizing that projects ...