IRR Rule

See: Internal Rate of Return.

Businesses are faced with an almost unlimited number of options for investing their money. Open another store, or expand the current locations. Launch a new product, or spend more on marketing for the current ones. Buy a small Caribbean island for executives to use as a resort, or pay for employee healthcare.

The IRR rule helps determine where a company should put its extra cash.

IRR stands for "internal rate of return." It refers to the amount a particular project will return. If you spend $1 million launching a new product and see $1.5 million in profit from that product, the IRR is 50%. One dollar spent in that area netted $1.50 back.

The IRR rule states that the return for a project needs to be greater than the cost of capital to fund that project. So if you have to pay 8% to borrow money to build a new location, you'd better get higher than 8% IRR from the new location. Otherwise, it isn't worth the investment.

If the IRR for any project you could chose would only equal 7%, for example, you might as well not borrow the money. Or, if you have the money already, you'd be better off loaning the cash out at interest. You'll earn more loaning the cash at 8% than you would spending the money on a new location and only bringing in 7%.