Internal Rate of Return: An IRR provides a measure of the “time value of money” and is the discount rate at which the amount of investment made at the time the investment is equal to the net present value of the future investment income and future return of invested capital. This is the most common measure when comparing the full rate of returns from one investment alternative to another. Looked at another way, IRR for an investment is the interest rate at which the net present value of all the cash flows [both funds invested upfront (and outflow of capital) and future receipts of income and returns of invested capital (and inflow of capital)] from an investment equals zero. The formula for IRR is:
0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively; and
IRR equals the project’s internal rate of return. An IRR can be calculated for debt or equity investment.
