Definition
IRR represents the annualized rate of return an investment is expected to generate. If IRR exceeds the hurdle rate (cost of capital), the project creates value. While intuitive, IRR has limitations: it assumes reinvestment at the IRR rate, can produce multiple solutions for non-conventional cash flows, and may rank mutually exclusive projects incorrectly.
functions Formula
NPV = Σ(CFt / (1+IRR)^t) = 0 (solve for IRR)
lightbulb Example
Invest $50K and receive $15K annually for 5 years. IRR ≈ 15.2%. If the cost of capital is 10%, the project clears the hurdle by 5.2 percentage points.
verified_user Key Points
- Compare IRR to cost of capital (hurdle rate)
- IRR > WACC means the project creates value
- Can produce multiple solutions with non-standard cash flows
- MIRR fixes reinvestment rate assumption