IRR

Internal Rate of Return

Short definition

IRR is the discount rate that sets a project’s NPV to zero. Above the hurdle (often WACC) an independent project looks acceptable; IRR does not settle scale, reinvestment or sign-change problems.

Detailed explanation

IRR is an internal yield on the dated cash flows and embeds the assumption that interim cash can be reinvested at the IRR. If that is unrealistic, use MIRR; if dates are irregular, use XIRR. More than one sign change can produce more than one positive IRR.

On mutually exclusive projects a high IRR rewards a small outlay; a larger lower-IRR project can produce more NPV. “IRR > hurdle” is an accept/reject screen for independent projects; ranking is by NPV. A credit pack’s equity IRR or debt yield uses a different cash definition.

Why it matters for the CFO

Boards read IRR as a percentage return; the CFO’s job is a common cash definition, tenor and hurdle. An inflated terminal value lifts IRR without delivering cash.

How it is calculated

NPV(IRR) = 0 ⇒ Σ CFₜ / (1+IRR)ᵗ = I₀

IRR solves NPV(r) = 0. Uneven periods belong to XIRR.

Variables in the formula

• IRR: rate that sets NPV to zero
• CFₜ: periodic incremental cash flow

How to read it

IRR minus WACC looks like a margin of safety but hides distribution and reinvestment. A very high IRR often means a short life or a small I₀. In FX cash flows, IRR is scenario-dependent.

Numerical example

I₀ = 10 mn TL, CF 4, 5, 6 mn TL over three years → IRR ≈ 22%; if WACC is 20% an independent project passes, but the mutually exclusive rival with higher NPV wins.

Definitions are educational. They are not investment, credit or tax advice.