Which statement correctly identifies Internal Rate of Return?

• A. Net present value.
• B. Payback period.
• C. Internal rate of return.
• D. Perpetuity.

Answer: (C)

The key idea here is what Internal Rate of Return actually represents. It is the discount rate that makes the net present value of a project’s cash flows equal to zero. In other words, IRR is the rate of return implied by the project’s cash flows.

This matters because you compare the IRR to your required return or hurdle rate; if the IRR exceeds that required rate, the project is attractive on a return basis.

Net present value describes the value resulting from discounting cash flows at a given rate, not the rate itself. Payback period measures how long it takes to recover the initial investment, which is about time, not rate. A perpetuity is an endless series of payments, a cash flow type, not a rate or a NPV calculation.

So the statement that correctly identifies Internal Rate of Return is the one that refers to the rate at which the project’s NPV becomes zero.