What is Internal Rate of Return (IRR), and how is it interpreted for a hospital investment?

• A. IRR is the discount rate that makes NPV zero.
• B. IRR is the discount rate that makes NPV positive.
• C. IRR is the discount rate that makes NPV negative.
• D. IRR is the discount rate that makes NPV zero when taxes are ignored.

Answer: (A)

Internal Rate of Return is the discount rate that makes the net present value of a project’s cash flows equal to zero. In a hospital investment, you model all expected cash inflows and outflows (usually using after-tax cash flows) and find the rate that brings NPV to zero. That rate represents the project’s annual return, assuming cash flows are reinvested at the same rate and occur as projected.

To interpret it, compare the IRR to the hospital’s required return or hurdle rate. If the IRR is higher than the hurdle rate, the investment is attractive because it’s expected to earn more than the minimum acceptable return. If it’s lower, it’s typically rejected; if it’s about the same, it’s a break-even proposition.

Taxes affect the cash flows you input, so the IRR you calculate reflects those after-tax results. Ignoring taxes is just a modeling simplification, not the definition of IRR. The key point remains: IRR is the rate that makes NPV zero.