Lesson 3 of 7 · 13 min

IRR, and choosing between IRR and NPV

The IRR is the discount rate that makes NPV zero; it is a handy percentage, but when it conflicts with NPV, NPV wins.

In short

The internal rate of return (IRR) is the discount rate at which NPV = 0.
Rule: invest if IRR ≥ r, the required return, which is why r is called the hurdle rate.
IRR equals the investor's actual return only if interim cash flows are reinvested at the IRR; NPV assumes reinvestment at r, usually more realistic.
If the cash flow signs change more than once, a project can have multiple IRRs; use NPV instead.
For mutually exclusive projects, choose the higher NPV, because IRR ignores the size and duration of the project.

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