Question

Which two of the following five statements are correct?

Select two alternatives:

• One potential problem with the IRR rule is that one can find several IRRs or that no IRR can be found for a specific stream of cash flows.
• The payback rule is reliable because it considers the time value of money and depends on the cost of capital.
• For the IRR rule it is possible that there exists no discount rate that will set the NPV equal to zero.
• If we use future value rather than present value to decide whether to make an investment, we will make a bad decision, since the future value will always be lower if the discount rate is positive.
• The NPV profile shows the payback period - the point at which NPV is positive.

Answer 1

The Correct statements are 1 and 3

Statement 1 Explanation : The Internal rate of return shows the average rate of return that the project gives over the period of the lifetime. The Number of Times the cash flows changes the sign the Number of IRR will exist and There may be case when there is no IRR in case the cash flows doesn't change the sign (Positive or Negative).

Statement 3 Explanantion: The IRR is the rate at which the future cash flows will be zero as comapred to the initial investment of the project. It also assumes that the Cash flows are reinvested at the IRR rate itself rather than the cost of capital, While the NPV assumes that the project cash flows are discoutned at the cost of capital so there may be case when there exist no IRR rate which sets NPV to zero.

The Payback period ignores the Time value of the moneyand the present value is less than the future value so statements 2 and 4 are wrong.

NPV profile shows that the projects at which cost of capital of the project equals that set the NPV to Zero.