The internal rate of return (IRR) is a valuable measure for determining the value of a project and should always be considered when deciding whether to fund a project. The IRR will certainly inform a loan institution about the financial feasibility of the project, but it will also tell the project owner if it is worth the risk.
The IRR is a discounted cash flow technique. It shows the rate at which the net present value of an investment becomes zero. In the most basic form, IRR is the projected interest rate of return assuming the project goes according to plan. The formula for determining IRR is complicated and involves some estimation to narrow down the approximate IRR.
When deciding on investing in a project, an organization must look at two key items: the cost of the project, or cost of funds, and the IRR. The IRR should always be the larger of the two numbers. For example, if it costs 8% to fund the project, then the IRR must be higher in order to off-set the cost and show a projected profit. Any organization should evaluate IRR to decide if the project makes sense for the business regardless of whether it is being funding internally or externally.
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