What Are the Advantages of Internal Rate of Return?

An internal rate of return is a financial calculation that has to do with the anticipated growth or return that some type of internal project can reasonably be expected to generate. A projection of this type is often prepared before a project is actually approved and launched, serving as part of the motivation for devoting resources to the effort. There are several advantages of internal rate of return projections, including the ability to sell the project to the powers that be and have a chance to actually meet or exceed that projected return.

One of the key advantages of internal rate of return is that this calculation can be used to justify the expenses associated with a project. By demonstrating that the total revenue generated from the project within a specified period of time will exceed the costs of launching and continuing a project, it is possible to gain and maintain support for the project. Since a rate of return (ROR) is usually expressed in terms of a percentage, using reliable and verifiable data to show the project will, within a given amount of time, post an internal rate of return that is considered equitable helps to increase the chances of getting the project off the ground.

Another of the advantages of internal rate of return is the ability to set a goal that can be used to measure the forward movement of the project, in terms of revenue generation. Under the best of circumstances, the project progresses on schedule and begins to generate revenue at a steady pace, making it possible to demonstrate that the projected return is highly likely to occur within the specified time frame. In cases where the project’s performance exceeds expectations, this may mean that the project managers can announce to investors that the projected rate of return is reached early in the period, which in turn means the actual rate of return at the end of the period will exceed the originally projected internal rate of return.

Since the advantages of internal rate of return projections have to do with both the pre-launch phase of a project and also as a measurement tool during the project, it is important to make sure the return projection is based solidly on fact and not on hope or intuition. Doing so helps to increase the chances of having the final rate of return at least match that initial return projection, and also sets the stage for possibly going beyond that percentage. While very helpful, it is only possible to enjoy the advantages of internal rate of return if that projected return is accurately forecasted. Otherwise, there is a good chance the actual returns will be somewhat disappointing, possibly leading to the cancellation of the project.