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IRR is the discount rate often used in capital budgeting that makes the net present value of all cash flows from a particular project equal to zero. IRR is the rate of growth a project is expected to generate. It is the rate of interest that makes the sum of all cash flows zero, and is useful to compare one investment to another.
Usually, higher a project’s internal rate of return, the more desirable it is to undertake the project. As such, IRR can be used to rank several prospective projects. Assuming all other factors are equal among the various projects, the project with the highest IRR is considered the best and undertaken first. IRR is sometimes referred to as “economic rate of return (ERR)”.
The actual rate of return that a given project ends up generating will often differ from its estimated IRR rate, a project with a substantially higher IRR value than other available options would still provide a much better chance of strong growth.
IRR helps in making a decision when comparing different projects, and is one of the several tools that can be used in evaluating any project that has cash flows distributed over the years.
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