IRR vs ROI: Yield Rate vs Simple Investment Gain
ROI measures total gain relative to invested capital. IRR measures the annualized discount rate implied by a full cash flow schedule.
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Use ROI for a simple gain-on-cost view. Use IRR when the timing of cash flows matters, especially when comparing investments with different holding periods.
ROI is useful for quick screening because it is easy to explain and does not require a full timing schedule.
IRR is better for capital allocation because it accounts for when cash returns arrive.
A high ROI over a long holding period can be less attractive than a lower ROI earned quickly.
Two projects with the same ROI
Project A returns 50% after one year. Project B returns 50% after five years. Simple ROI makes them look equal, but IRR reveals that Project A compounds capital far more efficiently.
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Frequently Asked Questions
Is IRR always better than ROI?
No. IRR is more complete for timed cash flows, while ROI is useful for quick gain-on-cost communication.
Why can ROI and IRR disagree?
They answer different questions. ROI measures total gain; IRR measures timing-adjusted yield.
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