Internal rate of return (IRR)
Principles of Finance glossary · Capital Budgeting
Definition
The discount rate that sets a project's NPV to zero. Decision rule: accept if IRR > cost of capital. Fails or produces multiple roots when cash-flow signs change more than once (non-conventional cash flows), and assumes reinvestment at the IRR itself rather than at the cost of capital - both reasons NPV is preferred for absolute ranking.
Internal rate of return (IRR) in plain English
Every investment is a trade — you put money in now and hope to get more back later — and the IRR is the single percentage that measures how good that trade is, like the effective yearly interest rate the project earns you. The rule of thumb: if a project's IRR beats what your money costs you to raise (your cost of capital), it's worth doing. But IRR has traps: if a project's cash flows flip between positive and negative more than once, the math can spit out several different "answers" or none at all, and it secretly assumes you can reinvest your winnings at that same high rate — often unrealistic. That's why finance pros usually trust NPV (net present value, the actual dollar value a project adds) over IRR when ranking which projects are truly best.
Also called: IRR
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