The internal rate of return is unreliable as an indicator of whether or not an investment...

The internal rate of return is unreliable as an indicator of whether or not an investment should be accepted given which one of the following? Multiple Choice

a.One of the time periods within the investment period has a cash flow equal to zero.

b.The initial cash flow is negative.

c.The investment has cash inflows that occur after the required payback period.

d.The investment is mutually exclusive with another investment of a different size.

e.The cash flows are conventional.

Solutions

Expert Solution

The correct answer is -

d.The investment is mutually exclusive with another investment of a different size.

Mutually exclusive projects means the firm has to make a decision to select one project and reject another. In Mutually exclusive projects acceptance of one means rejection of other.

In case of mutually exclusive projects with different size of two projects, IRR may give unrealistic or conflicting decisions as IRR will prefer the project which are smaller in size which may not be providing more absolute returns.

In other options IRR will give realistic decisions as-

IRR of a proposal is defined as the discount rate at which NPV is 0. It is the rate at which the present value of cash inflows is equal to present value of cash outflows. It is usually the rate of return the project earns.

--> IRR provides realistic results when the cashflows are conventional (in same series - one negative cashflow and series of positive cashflow).

--> Initial cashflow is negative in case of conventional cashflows.

--> There is no problem with One of the time periods within the investment period has a cash flow equal to zero and if The investment has cash inflows that occur after the required payback period.

Hope it helps!

jeff jeffy answered 1 year ago

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