Question

Define Internal Rate of Return and explain what it measures.

Answer 1

Internal rate of return IRR is measure which is extensively used in Corporate finance in capital budgeting. It is that rate which makes the net present value zero. It does not depend on the cost of capital or inflation and is thus, internal to the company. Company can compare it with cost of capital to see if any project is worth undertaking. If the internal rate of return is less than the cost of capital then it would not make any sense for the company to invest. IRR is thus an estimate of how much return can be generated in future from a project. It is therefore used to measure profitability from investing in a project. It measures the break even discount rate. If IRR is more than cost of capital it can probably be expected to undertake the project.

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