Internal Rate of Return (IRR) is one of a number of discounted cash flow (DCF) techniques (the other is net present value or NPV) used in comparative appraisal of investment proposals where the costs and benefits occur over a number of different time periods.
IRR is the average annual return earned through the life of an investment and represents the discount rate that reduces to zero the net present value of a stream of income inflows and outflows. If the IRR is higher than the desired rate of return on investment, then the project is a desirable one.
It is important to remember that IRR is a mechanical method (computed usually with a spreadsheet formula) and not a consistent principle. It can give wrong or misleading answers, especially where cash flows include multiple investment points.
Below is a simplified worked example of an IRR calculation to aide understanding.