IRR is the discount rate at which the net present value (NPV) of future cash flows from a capital investment equals zero. Capital expenditure is the primary factor in determining a market’s IRR, along with incentives and operating expenses. Put simply, it provides an apples-to-apples metric for investors to compare demand and project growth across disparate markets.
In a competitive market with no excess profits, the IRR will equal the risk adjusted discount rate.
If a project has an NPV greater than zero, the project creates value and should be undertaken. One can provide in a gas project the breakeven gas price (BEP), which represents the gas price needed to ensure that a project’s NPV is zero, and as such that it is the price needed for the project to be value neutral. If the realizable price is above the BEP, then the project will create value and should be pursued. If not, then the project would destroy value and should not be undertaken.
In the calculation of investments for offshore oil and gas drilling in Israel, economists often take a risk adjusted discount rate of 9%. Insofar as the IRR applies to rate of return on a project, it is sometimes referred to as the project internal rate of return