What is the internal rate of return (IRR)?

The internal rate of return (IRR) is indeed defined as the discount rate that makes the net present value (NPV) of an investment zero. This means that when the cash flows from the investment are discounted back to their present value using the IRR, the total present value of those cash flows is equal to the initial investment cost, resulting in an NPV of zero.

This concept is crucial in investment analysis, as it represents the effective annual return on invested capital. If the IRR is higher than the required rate of return or the cost of capital, the investment can be deemed favorable. In contrast, if it's lower, the investment would not meet performance expectations.

Understanding this definition of IRR is essential for making informed investment decisions, distinguishing it from other financial metrics, and gauging potential profitability based on projected cash flows.