What does the Internal Rate of Return (IRR) represent?

The Internal Rate of Return (IRR) is defined as the discount rate that makes the Net Present Value (NPV) of a series of cash flows equal to zero. This metric is crucial in evaluating the profitability of an investment or project. When the cash inflows generated by the project equal the cash outflows when discounted at the IRR, it indicates that the project will break even in terms of NPV. Thus, IRR is often used by investors and analysts to compare the relative attractiveness of different investment opportunities; if the IRR exceeds the required rate of return, the project may be considered a good investment.

In contrast, the other options describe different financial concepts. The average cost of capital pertains to the overall cost of financing a firm, which usually includes both debt and equity components. The total profit over the lifespan of the investment provides a measure of absolute profit but does not take the timing of cash flows into account, which is essential in discounted cash flow analysis. The return on equity refers specifically to the profitability for equity shareholders and is distinct from the broader concept of IRR, which encompasses all cash flows related to the investment.