IRR

IRR

Internal rate of return (IRR) is a financial metric used to estimate the annualized rate an investment is expected to generate on the amount of capital invested. It expresses the profitability of a project as a percentage, rather than as a dollar amount as with net present value.

If IRR exceeds the cost of capital, the investment is generally considered favorable; an IRR below the cost of capital is considered unfavorable.

What is IRR and why is it important?

The internal rate of return (IRR) is a valuation technique that estimates the annualized rate of return generated by an investment based on its expected cash flows. Specifically, IRR is the discount rate that sets a project’s net present value equal to zero.

Eighty-three percent of financial professionals say IRR is important to their organization’s decision-making process, according to the 2026 AFP Cost of Capital Survey. Because IRR translates projected cash flows into a single percentage figure, it makes it easier to compare investment opportunities of different sizes and time horizons, and assess whether a project meets required return thresholds.

What is IRR used for?

IRR is used to evaluate and compare capital investments by measuring their expected rate of return. It is commonly applied in corporate finance, private equity and investment analysis, particularly when comparing projects of similar scale, or when an appropriate discount rate is difficult to determine.

IRR formula

The internal rate of return formula is as follows:

0 = NPV = T ∑ t = 1 Ct (1 + IRR)t − C0

In practice, IRR is calculated using financial calculators or spreadsheet software (e.g., Excel) that employs an iterative process to identify the specific discount rate at which the net present value (NPV) of all cash flows equals zero.

Once the IRR has been determined, it is compared against the company’s cost of capital (or a risk-adjusted hurdle rate) to evaluate potential value creation.

IRR vs. NPV

While IRR may be intuitive and easy to communicate, it has its limitations.

  • It assumes cash flows are reinvested at the same rate.
  • It can be misleading when comparing projects of different sizes.
  • It may not produce a single clear result when cash flows are irregular.

For these reasons, many corporate finance and treasury organizations rely on NPV as the primary decision metric and use IRR as a complementary measure.

For a detailed comparison, see Net Present Value vs. Internal Rate of Return.

IRR FAQs

Why do NPV and IRR sometimes lead to different decisions?
Conflicts between NPV and IRR generally arise from differences in project scale, cash flow timing and reinvestment assumptions. IRR implicitly assumes interim cash flows are reinvested at the project’s own internal rate, whereas NPV assumes reinvestment at the firm’s cost of capital.

How can I adjust for IRR’s reinvestment assumptions?
Using the MIRR function in Excel allows you to specify distinct rates for financing negative cash flows and for reinvesting positive cash flows. This can provide a more realistic assessment of project profitability.

What is a good IRR?
A “good” IRR depends on the organization’s required rate of return and risk tolerance. In general, a higher IRR indicates greater profitability relative to the initial investment. Ultimately, the IRR needs to be high enough to compensate for a project’s specific risk profile, liquidity constraints and the organization’s strategic goals.

Can IRR be negative?
Yes. A negative IRR indicates that projected cash flows are insufficient to recover the initial investment.

Should IRR be used alone?
IRR is best used alongside NPV and other metrics to support well-informed capital budgeting decisions.