Project Management Institute (PMI) Professional in Business Analysis Practice Exam

What does Internal Rate of Return (IRR) represent?

1. The percentage growth rate an investment is expected to yield

2. The total costs associated with a project

3. A method for calculating project timelines

4. The overall revenue generated by a project

The correct answer is: The percentage growth rate an investment is expected to yield

Internal Rate of Return (IRR) is a significant financial metric used to evaluate the profitability of an investment or project. It represents the percentage growth rate that an investment is expected to yield over time. Specifically, IRR is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. By establishing a percentage that indicates the expected growth, IRR helps investors and project managers determine whether the projected returns justify the investment when compared to other potential investments or benchmarks. In practice, if the IRR exceeds the cost of capital or a required rate of return, the investment is generally considered favorable. The other choices do not accurately capture the essence of IRR. The total costs associated with a project pertain to budgeting and financial forecasting rather than return on investment. A method for calculating project timelines focuses on scheduling and planning activities rather than financial returns. The overall revenue generated by a project is a broader concept that doesn't specifically address the efficient rate of return based on cash flow timing and investment. Understanding IRR as the growth rate helps practitioners assess and compare different investment opportunities effectively.