Sage-Tips

What are the problems with internal rate of return?

Without modification, IRR does not account for changing discount rates, so it’s just not adequate for longer-term projects with discount rates that are expected to vary. Another type of project for which a basic IRR calculation is ineffective is a project with a mixture of multiple positive and negative cash flows.

Which of the following is a weakness of the internal rate of return IRR?

Which of the following is a weakness of the internal rate of return (IRR)? IRR assumes that the cash inflows from the project are immediately reinvested at the internal rate of return. Which of the following is not an advantage of post-audits of capital investments?

What does internal rate of return depend on?

What is a good internal rate of return? Whether an IRR is good or bad will depend on the cost of capital and the opportunity cost of the investor. For instance, a real estate investor might pursue a project with a 25\% IRR if comparable alternative real estate investments offer a return of, say, 20\% or lower.

Which of the following is a defect of the IRR method versus the NPV?

One defect of the IRR method versus the NPV is that the IRR does not take account of the cost of capital. One defect of the IRR method versus the NPV is that the IRR values a dollar received today the same as a dollar that will not be received until sometime in the future.

Why is the IRR measure potentially misleading?

Many investors mistakenly compare IRR to annualized returns to make investment decisions, which can be a costly mistake. IRR also assumes all distributions will be reinvested immediately, which means there is a built-in compounding assumption that actually doesn’t happen.

Which of the following is a weakness of the internal rate of return method for screening investment projects?

A weakness of the internal rate of return method for screening investment projects is that it: A. implicitly assumes that the company is able to reinvest cash flows from the project at the company’s discount rate.

What is the attribute of the internal rate of return?

The IRR (internal rate of return) is the interest rate (also known as the discount rate) that will bring a series of cash flows (positive and negative) to a net present value (NPV) of zero (or to the current value of cash invested).

Should the IRR be high or low?

Generally, the higher the IRR, the better. However, a company may prefer a project with a lower IRR, as long as it still exceeds the cost of capital, because it has other intangible benefits, such as contributing to a bigger strategic plan or impeding competition.