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Wize University Introduction to Finance Textbook > Capital Budgeting

Internal Rate of Return

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Internal Rate of Return

Internal rate of return (IRR) is a metric used in capital budgeting, measuring the profitability of potential investments.
  • Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero.
  • When comparing two potential investments, the investment with a higher IRR is more attractive.
  • If IRR > r, then NPV > 0 (investment is profitable)
  • If IRR < r, then NPV < 0 (investment is not profitable)
  • If IRR = r, then NPV = 0 (investment breaks-even)
  • Exact value for IRR can be calculated quickly using financial calculator.


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Example: Internal Rate of Return (IRR)

You are considering 5-year investment that will require an initial cash outlay of $40,000. The expected inflows in years 1 through 3 are $10,000; then $12,000 in year 4 and $20,000 in year 5. Your cost of capital is 12% per year.

What is the IRR of the investment and is the investment profitable

Practice: Internal Rate of Return (IRR)

An investment requires an initial after-tax cash outlay of $6,000 and will return $3,000 in the first year, $3,000 in the second year and $4,000 in the third. If the investor's cost of capital if 9%, what is the internal rate of return of this investment?

Round final answer to 2 decimal places
The internal rate of return is
%
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Example: Internal Rate of Return

Calculate the IRR of an investment that requires an upfront outflow of $100,000 and will return $24,000 per year forever.

Practice: Net Present Value

An investment requires an initial after-tax cash outlay of $50,000. The investor will receive $8,000 per year indefinitely.

What is the IRR of the investment?

Round your final answer to 2 decimal places
The IRR is
%
Extra Practice
Question 2
A project requires an initial investment of $100,000 and will return $30,000 per year indefinitely. The firm's average cost of capital is 8% and this project is slightly riskier than their usual operations.
Risk premiums:
Question 1
A firm is considering a project with an initial after-tax cash outflow of $5,000 and inflows of $1,000 in year 1, $6,000 in year 2 and $3,000 in year 3. The firm's cost of capital is 6% .
Compute the internal rate of return for this project.
ABC Company is considering a new project that will require an initial investment of $100,000. The project is expected to generate the following cash flows over the next five years:
Year 1: $30,000 Year 2: $40,000 Year 3: $50,000 Year 4: $40,000 Year 5: $30,000
The required rate of return for this project is 10%.