The internal rate of return identifies the rate of return that different investments have such that they're a wash, your costs are equal to the flow of cash received from the investment. Here is what we're doing, is we're asking the question, what is the rate of return such that my net present value is zero? And then we can compare two different investments. Now when we're looking at net present value, we assume that there's a rate of return, 5%, 10%, 12%, what have you and then we calculate our NPV based on that interest rate. For the internal rate of return, what we're doing is we're setting our condition such that our costs are exactly equal to our cash flow. And then what we're doing is we're calculating the interest rate that would define that identity. Then we can use that interest rate to determine if we should take one investment over another. Here's an example. Suppose we have an initial investment of $10,000 and this investment generates cash flows in the amount of $2,000 in years 1 & 2, $2,500 in year 3, and $3,000 in years 4 & 5. What we can do is we can assume an interest rate, let's suppose 5% and we can calculate what is the NPV. Or we can assume that the NPV is zero and then calculate the internal rate of return. If I were to do the latter, then I calculate the internal rate of return of this investment as being 7.29%. In this case, we could then look at multiple investments and identify which investment has the highest internal rate of return. We always want the investment that has the highest rate of return. This gives us a very clear decision rule. The advantages of the internal rate of return are that it considers the time value of money. It also considers a required rate of return, it gives it in a percentage. The disadvantage is that again, it is very susceptible, very subject to assumptions about future cash flows. You change the future cash flow, you're going to change the internal rate of return. And because your time horizon may be unknown and your cash flow may be unknown, your internal rate of return is sometimes an educated guess. This doesn't mean it's bad. It doesn't mean that it shouldn't be used. What it means is that you have to be very cautious about making the assumptions about what your cash flows are so you can get as close to a realistic internal rate of return as possible. It's incredibly easy to use. Again, very digestible, gives you a percentage that people can gravitate towards, but you have to be careful about the assumptions that you're using.