# Internal Rate of Return - Explained

What is an Internal Rate of Return?

# What is an Internal Rate of Return?

Internal rate of return (IRR) refers to a metric utilized in capital budgeting to estimate how profitable potential investments are. Internal rate of return refers to a discount rate which makes all cash flow's net present value (NPV) from a specific project equal to zero. Internal rate of return calculations depends on the exact formula NPV relies on. Below is the formula for calculating Net Present Value: The formula for calculating NPV. Where: "Ct" represents net cash flow during the t period "Co" represents total initial investment costs "r" represents the discount rate "t" represents the number of time periods In order to calculate IRR with the formula, NPV must be stealing equal to zero and then calculate for the (r) discount rate, which is the internal rate of return. Because of the formula's nature, however, IRR can't be solved analytically and instead, must be solved either by utilizing a software program or trial-and-error to calculate IRR. In general, the higher the internal rate of return of a project, the more pleasant it is to take on. Internal rate of return is uniform for various types of investments, thus IRR can be utilized in ranking many likely projects on a somewhat even basis. In a situation where the investment costs are equal among the different projects, the project having the highest IRR will most likely be termed the best and thus, undertaken first. Sometimes, IRR is referred to as "a discounted cash flow rate of return" or "economic rate of return." Using "internal" implies external factor omission, like the capital or inflation cost, from the calculation.