What is Internal Rate of Return (IRR)?
The internal rate of return (IRR) is the discount rate at which the net present value of a project’s cash flows equals zero, used to rank investment alternatives and compare expected returns against a hurdle rate.
How It Works
- Solve for r where NPV = Σ(CFt / (1+r)^t) – initial investment = 0.
- Accept if IRR > cost of capital (hurdle rate).
- Multiple IRRs possible if cash flows switch signs more than once.
- Modified IRR (MIRR) adjusts for reinvestment assumption.
Saudi Context
Saudi corporate finance teams typically use a hurdle rate of 10% to 15% in SAR-based projects, calibrated to the cost of capital and SAMA’s repo rate. PIF-backed projects and Vision 2030 initiatives often apply lower hurdles (7% to 10%) reflecting strategic priorities, while private-sector industrial projects use higher hurdles to reflect execution risk.
Example
A Saudi factory invests SAR 10,000,000 today and expects SAR 3,000,000 cash inflow annually for 5 years. The IRR that makes NPV = 0 is approximately 15.2%, above the 12% hurdle, so the project is accepted.