The internal rate of return is
The internal rate of return is unreliable as an indicator ofwhether or not an investment should be accepted given which one ofthe following? Multiple Choice
a.One of the time periods within the investment period has acash flow equal to zero.
b.The initial cash flow is negative.
c.The investment has cash inflows that occur after the requiredpayback period.
d.The investment is mutually exclusive with another investmentof a different size.
e.The cash flows are conventional.
Answer:
The correct answer is –
d.The investment is mutually exclusive with anotherinvestment of a different size.
Mutually exclusive projects means the firm has to make adecision to select one project and reject another. In Mutuallyexclusive projects acceptance of one means rejection of other.
In case of mutually exclusive projects with different size oftwo projects, IRR may give unrealistic or conflicting decisionsas IRR will prefer the project which are smallerin size which may not be providing more absolutereturns.
In other options IRR will give realistic decisions as-
IRR of a proposal is defined as the discount rate at which NPVis 0. It is the rate at which the present value of cash inflows isequal to present value of cash outflows. It is usually the rate ofreturn the project earns.
–> IRR provides realistic results when the cashflows areconventional (in same series – one negative cashflow and series ofpositive cashflow).
–> Initial cashflow is negative in case of conventionalcashflows.
–> There is no problem with One of the time periods withinthe investment period has a cash flow equal to zero and if Theinvestment has cash inflows that occur after the required paybackperiod.
Hope it helps!
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