what is Internal rate of return?

Question

It is the return for a company on their investments

Answer 1

The internal rate of return (IRR) is a way of putting a number to how profitable a potential business enterprise is. It is used to try to compare investment opportunities with very different proejcted cash flows, to come down to a particular number (IRR) that represents the overall value of each investment considering not simply the amount of money it generates, but the length of the investment. Money earned late in the investment is worth less (in this calculation) than money earned early on, because the money earned early on can be reinvested during the course of the business enterprise.

The problem with this method (IRR) is that it assumes that the money earned each month is re-invested in something that pays as much interest as the investment as a whole earns in the long-term. In reality, if your business generates cash each month and then a large amount at the end of the project, the lower amounts of cash each month will be invested in the bank or something that doesn't have as high a yield as the project as a whole (considering the earnings later on). If the IRR is 20% (not unrealistic for a real estate investment, where you can make a lot of money selling the appreciated property at the end of the investment), the rental income cannot be invested each month at 20%, so the IRR is inflated.

There's a better way of calculating, called a "modified internal rate of return" (MIRR), in which you pick a realistic percentage to use to calculate the interest earned on the excess cash flow generated each month. The formula is then used to determine what the overall return is, taking into account the amount of money generated each month and how much is generated each month.

http://en.wikipedia.org/wiki/Modified_Internal_Rate_of_Return

Answer 2

The internal rate of return (IRR) is a capital budgeting method used by firms to decide whether they should make long-term investments.
The IRR is the 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 interest that could be earned by alternative investments (investing in other projects, buying bonds, even putting the money in a bank account). The IRR should include 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 cashflows.
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.

Answer 3

Not quite. It's a way of comparing investment opportunities.

The internal rate of return is a net present value calculation. The IRR is the % discount factor used to generate a zero net present value for a given investment.

Basically it is a method of assessing investments, before the investment is made. It isn't used to measure the return on the investment once it has been made. For that companies would use return on capital employed, or some other measure.

Answer 4

he internal rate of return (IRR) is a capital budgeting method used by firms to decide whether they should make long-term investments.

The IRR is the 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 interest that could be earned by alternative investments (investing in other projects, buying bonds, even putting the money in a bank account). The IRR should include an appropriate risk premium.