How does IRR provide insight into an investment's potential?

The internal rate of return (IRR) is a key financial metric that reflects the annualized rate of return an investment is expected to generate over time. This percentage measure incorporates all cash inflows and outflows associated with the investment, adjusted for the timing of those cash flows. By calculating IRR, investors can gain insight into the profitability of the investment relative to the cost of capital or other investment opportunities.

When IRR is compared to a required rate of return or benchmarks, it helps decision-makers assess whether the investment is likely to meet their financial performance expectations. A higher IRR suggests that the investment may be a more attractive option, as it indicates a greater potential for generating returns over its duration.

This metric is particularly useful as it provides a single percentage figure that encapsulates the investment's potential, making it easier for investors to compare different opportunities and make informed decisions.