Question

Let’s say an investment salesperson outlines a new program whereby you invest $10,000 today and receive $25,000 in 5 years. Which of the following statements is true?

This is a bad investment because the return is inadequate.

You can calculate the IRR of this investment from the information given, but you cannot evaluate it.

This is clearly a good investment because you get back $15,000 more than you paid, a 150% return.

You can calculate the PV of this investment from the information given, but you cannot evaluate it.

Answer 1

The correct statement is -

You can calculate the IRR of this investment from the information given, but you cannot evaluate it.

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. Based on the initial outflow and the future cash flows IRR can be calculated as there is no need of discount rate to calculate IRR, IRR itself provides the rate which is the return of the project.

But for evaluating the worthiness of the investment the required rate of return is required. Here in question no required rate (discount rate) is given hence you cannot evaluate it.

Other options are incorrect because -

---> Present value can not be calculated without the required rate (discount rate).

---> We cannot say it is a good or bad investment unless some required rate of return is give.

Hope it clarifies!