Internal Rate of Return
Internal Rate of Return: (IRR) calculates the overall annual percentage rate of return on an investment, especially where several different variables are involved. In the case of bonds, the redemption yield is an internal rate of return. It takes into account variables such as periodic interest payments, the price paid, the time to maturity, and the price at redemption. In its simplest form, where a single purchase and a single sale are made, and no income is received in the meantime, the IRR is the compound annual rate of return calculated from the buying price to the sale price.
IRRs are used by venture capitalists to set a target “exit price” and then work backwards to determine what up front investment is attractive. IRR can also be applied to calculate reinvested return on equity (stocks) when calculating the compound return implied by an investment. Of course, the goal is to achieve an IRR that is well above the prevailing risk free rate of returns.
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