Internal rate of return

In this lesson

1. 0:00 Introduction to Internal Rate of Return
2. 1:31 How IRR works for single-year investments
3. 3:26 IRR for multi-year projects and decision rules
4. 5:18 Understanding the NPV profile graph
5. 10:15 Linear interpolation formula explained
6. 15:10 Worked example: calculating IRR step by step
7. 18:16 IRR versus NPV: strengths and weaknesses

About this lesson

You'll discover why IRR is so widely used in real-world finance, how to apply the decision rule (accept if IRR exceeds cost of capital, reject if lower), and crucially, how it compares to NPV when evaluating projects. The lesson starts with the fundamentals: what IRR actually means as an average annual percentage return on an investment, and how to work it out for simple one-year investments. You'll then move into the linear interpolation formula—the method you'll be examined on—which finds the exact discount rate where a project's NPV equals zero. The session walks you through the formula step by step, showing you how to identify two discount rates (one giving positive NPV, one negative) and calculate the IRR that falls between them. Worked examples demonstrate the calculation in practice, with tips on avoiding common errors like handling negative numbers correctly. The lesson also explores the critical strengths and weaknesses of IRR versus NPV. While IRR is easier to communicate to stakeholders (a 15% return is intuitive), it has a significant limitation: it's a relative measure that doesn't always lead to maximising shareholder wealth when comparing mutually exclusive projects. You'll learn why NPV remains theoretically superior for decision-making, even though IRR remains popular in practice. By the end, you'll be confident using IRR in exam questions and understand when and why to rely on each appraisal technique.

Duration: 21m