# What Is IRR And How Do Companies Use It?

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## Investing: What is IRR?

Management’s main goal is creating shareholder value. Achieving this requires capital budgeting decisions that give positive expected returns, also known as the Internal Rate Of Return (IRR).

## Calculation of IRR

Interestingly enough, calculation of an internal rate of return first requires the formula for Net Present Value (NPV) of a project. When we refer to “project” we assume it means any capital budgeting decision management faces.

Here:

Ct = net cash flow during period t

C0 = total investment costs

r = discount rate

t = number of periods

We solve for r, which is the discount rate. Additionally, we do this buy setting NPV = 0. This cannot be done analytically, so we use software, or trial and error methods.

## How To Interpret IRR

Furthermore, internal rate of returns are paramount in management’s course for their respective business. Management looks for projects with the highest IRR because it is the most efficient use of their capital.

Additionally, returns that surpass US T-Bills and stock buybacks create value for shareholders. The actual rate of return often differs from that of the calculated IRR. However, this metric gives management an idea of which avenue to explore.