Internal rate of return (IRR)

The internal rate of return (IRR) is a method for deciding whether to make a capital expenditure which is related to discounted cash flow. IRR is equivalent to the earning ability of the amount of money (capital sum) to be spent at which the NPV (net present value) is zero.

What is it used for?

It is used for calculating whether particular projects will be good investments and helps to clarify the level of risk and return involved in new ventures. It can be used to help with buying decision making. It is used to determine whether to purchase new equipment for projects or not.

How do I use it?

IRR is often calculated using a financial calculator or is identified by using NPV tables until a percentage close to zero is reached.

What are its limitations?

A positive internal rate of return is not necessarily the only reason for capital expenditure to go ahead. There may be other reasons for expenditure, such as increasing reliability or performance.

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