Final answer:
The internal rate of return (IRR) makes the net present value (NPV) of the project zero by determining the break-even interest rate for the investment's cash flows. It is a critical metric considered against a company's cost of capital when planning investments, such as when a firm factors in societal spillover benefits which might prompt greater investment.
Step-by-step explanation:
The internal rate of return (IRR) is a financial metric used in capital budgeting to assess the profitability of potential investments. The definition of IRR is that it is the interest rate at which the net present value (NPV) of all the cash flows (both positive and negative) from a project or investment equal zero. In simpler terms, the IRR is the break-even interest rate that makes the present value of the costs of the investment equal to the present value of the benefits. If the IRR of a new project equals a company's required rate of return, the project's NPV will be zero.
Let's apply this concept using the given data: If the cost of financial capital is 9%, but by capturing the 5% return to society, the company effectively faces an IRR of 4%, then it will plan investments accordingly to maximize its benefits. This involves considering spillover benefits to society, which typically leads to higher investment levels (e.g., $183 million as given in the reference). Overall, the IRR signals how much an investment can yield and influences investment decisions against a company's cost of capital.