What is IRR?

IRR stands for Internal Rate of Return. It is a financial metric used to estimate the profitability of potential investments or projects. Specifically, IRR is the discount rate that makes the net present value (NPV) of all cash flows from an investment equal to zero^{[1][2][3][4][5][6][7]}.

How Does IRR Work?

IRR represents the annualized effective compounded return rate an investment is expected to generate^{[1][2][4][5][6]}.
It accounts for the timing and size of all cash flows—both inflows and outflows—over the life of the investment^[1][2][5][6].
When the IRR equals or exceeds a company’s required rate of return (or "hurdle rate"), the investment is typically considered attractive^[3][4][6].

IRR Formula

The IRR is the rate (r) that solves the following equation:

0 = CF₀ + CF₁/(1+r)¹ + CF₂/(1+r)² + ... + CFₙ/(1+r)ⁿ

CF₀, CF₁, ..., CFₙ = Cash flows at time periods 0 through n
r = Internal rate of return

Why is IRR Important?

It allows investors and companies to compare the profitability of different investments or projects on a consistent basis^[2][3][5][6].
IRR is widely used in capital budgeting to help decide which projects to pursue^{[2][3][4][5][6]}.
It helps assess whether a project will generate returns above the cost of capital^[4][6].

Key Points to Remember

Higher IRR generally indicates a more desirable investment, assuming similar risk and scale^[2][5].
IRR does not measure total dollar returns, but rather the annualized return rate that balances all cash flows^[2][5].
It should be used alongside other metrics, such as NPV, for better investment decisions^[3][4][5].

Return to IRR Calculator