Internal Rate of Return

The internal rate of return is the discount rate that makes an investment's net present value zero. In plain terms, it is the annual percentage return the investment produces.

It is convenient because the answer is a single percentage. An IRR of 12% simply means a 12%-a-year investment, and if your cost of funding is 8%, the case makes sense.

It is especially useful where money goes in and out at various times, as in property or private equity. A simple return figure cannot reflect timing; IRR can.

The caution is that it ignores scale. A 50% IRR on 1,000 leaves far less money than a 20% IRR on a million. That is why it should be read alongside net present value.

Cash flows that flip between positive and negative repeatedly can also yield multiple IRRs or render the figure meaningless. It works best on straightforward structures.