IRR

The internal rate of return (IRR) = The one single interest rate that discounts cash flow values to zero. If the sum of this cash flow series for all values from time period 0 = At/(1+R)t > n = 0. A = the cash flow in period t, n = the number of periods, then R is the internal rate of return (IRR).

There are several pitfalls when applying IRR as the sole arbiter of investment decisions.

For example, the investment may attract a large tax depreciation tax shelter benefit in year 1 and then recurring annual after tax income thereafter, which may give rise to two IRR values (two values where the sum of discounted cash flows equals zero - one early and one later in the forecast period).

Also when comparing mutually exclusive projects may give rise to higher IRR values for the project which has lower net present value. One measure is simply a percentage and one is cash.

Always check your IRR results with the net present value calculations.

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NPV

Discounted Cash Flow