Question

If you compare the internal rate of return to the net present value,

• the IRR is more reliable when you are evaluating mutually exclusive projects.

• the IRR is easier to apply when the cash flows are non-normal.

• they are very similar because the IRR is the discount rate that makes the NPV equal to one.

• will provide the same accept or reject answer unless you have scale differences between projects.

• will provide the same accept or reject answer if you have two independent projects with normal cash flows.

Answer 1

Correct answer is both 4th and 5th.

If you compare the internal rate of return to the net present value-

• will provide the same accept or reject answer unless you have scale differences between projects. ( IRR and NPV may rank projects differently due to size disparity also. IRR will prefer the project which are smaller in size but NPV will be more of larger investment project.) If there is no scale difference IRR and NPV will give same results.

• will provide the same accept or reject answer if you have two independent projects with normal cash flows.

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.

In case of mutually exclusive projects IRR and NPV can give opposite results. When there is conflict between IRR and NPV result, NPV is more reliable as IRR is based on assumption that the intermediate cashflows are reinvested at IRR which is unrealistic and NPV doesnot have any such assumption. It has realistic reinvestment rate assumption. It assumes all the intermediate cash inflows are reinvested at cost of capital.

IRR is difficult to calculate when cash flows are not normal.

Hope it helps!