Internal Rate of Return
The internal rate of return (IRR) is a capital budgeting method typically used by institutional investors to decide whether they should make a long-term investment, typically 5 to 10 years.
The IRR is the return rate which can be earned on the invested capital, i.e. the yield on the investment. A project is a good investment proposition if its IRR is greater than the rate of interest that could be earned by alternative investments, i.e. investing in other projects, buying bonds, even putting the money in a bank account. The internal rate of return should include an appropriate risk premium.
In general, if the internal rate of return is greater than the project’s cost of capital, or hurdle rate, the project will add value for the company. The IRR example provided is designed for institutional investors that typically work with investment capital that is borrowed and need to estimate an internal rate of return for comparison and analysis scenarios. The WebVest © IRR analysis provides for structuring a investment for up to ten years including financing and amortization structure, supplemental or earn-out financing, subsequent cash flows, principal reduction, cash on cash return and a Performa exit strategy for selling the investment.