Which method calculates the unique rate of return of an investment?

The internal rate of return (IRR) is the method that calculates the unique rate of return of an investment. It represents the discount rate at which the net present value (NPV) of all future cash flows from an investment equals zero. Essentially, the IRR is the rate that makes the investment break even in terms of NPV, providing a single percentage that reflects the potential profitability of the investment relative to its cost. This is particularly useful for comparing the attractiveness of various investment opportunities or projects.

In contrast, net present value assesses the total value created by an investment by summing the present values of incoming cash flows and subtracting the initial investment, but it does not yield a singular rate of return like the IRR. The payback period focuses on the time it takes to recover the initial investment without considering the overall profitability or the time value of money. Return on investment (ROI) measures the overall profitability of an investment relative to its cost but does not specify a unique rate for discounting future cash flows. Hence, the internal rate of return is distinct in its ability to articulate a specific rate that governs an investment’s expected profitability.