What does the Internal Rate of Return (IRR) achieve?

The Internal Rate of Return (IRR) is a crucial concept in corporate finance, particularly in investment appraisal. It specifically refers to the discount rate at which the total present value of the cash inflows from an investment equals the total present value of the cash outflows, thereby making the Net Present Value (NPV) of the investment equal to zero.

This characteristic makes IRR a useful tool for evaluating the profitability of potential investments. When assessing project viability, if the IRR is greater than the required rate of return (or hurdle rate), the investment is considered worthwhile. Understanding this concept is essential because it allows managers and investors to compare the intrinsic worth of different investment opportunities based on their projected cash flows.

In contrast, the other options do not accurately define what the IRR is. The average return on equity relates to the performance metrics of equity investors rather than the specific discounting mechanics of cash flows. The overall risk of an investment involves different measures, such as standard deviation or beta, rather than the IRR itself. Lastly, while IRR can indicate the rate of return that an investor might expect, it does not directly represent the required return by investors, which is better defined by the cost of capital or required rate of return based