Final answer:
The internal rate of return (IRR) is a technique of investment appraisal that measures the profitability of an investment. It is the discount rate at which the net present value (NPV) of the project is zero. A higher IRR indicates a more profitable investment.
Step-by-step explanation:
The internal rate of return (IRR) is a technique of investment appraisal that measures the profitability of an investment. It is the discount rate at which the net present value (NPV) of the project is zero. In other words, it is the rate at which the present value of the cash inflows equals the present value of the cash outflows.
For example, let's say you are considering an investment in a project that requires an initial investment of $10,000 and is expected to generate cash inflows of $5,000 per year for the next 5 years. By calculating the IRR, you can determine the rate of return that would make the NPV of this project zero, indicating that it is a worthwhile investment.
A higher IRR indicates a more profitable investment, as it represents a higher rate of return. However, it's important to note that the IRR may not always be the most accurate measure of profitability, especially when comparing projects of different sizes or durations.