Answer Posted / prasanna
The internal rate of return (IRR) is a capital budgeting
metric used by firms to decide whether they should make
investments. It is an indicator of the efficiency of an
investment, as opposed to net present value (NPV), which
indicates value or magnitude.
The IRR is the annualized effective compounded return rate
which can be earned on the invested capital, i.e., the
yield on the investment.
A project is a good investment proposition if its IRR is
greater than the rate of return that could be earned by
alternate investments (investing in other projects, buying
bonds, even putting the money in a bank account). Thus, the
IRR should be compared to any alternate costs of capital
including an appropriate risk premium.
Mathematically the IRR is defined as any discount rate that
results in a net present value of zero of a series of cash
flows.
In general, if the IRR is greater than the project's cost
of capital, or hurdle rate, the project will add value for
the company.
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