Technical problems associated with the internal rate of return include: a. the p

Question

Technical problems associated with the internal rate of return include: a. the possibility of multiple IRRs, which rarely present practical difficulties b. the assumption that all cash flows arc reinvested at the IRR c. neither of the above d. both of the above 13. A project's NPV profile will cross the horizontal axis at: a. the cost of debt. b. the cost of capital. c. the internal rate of return. d. zero. 14. The profitability index (PI) is particularly useful in comparing mutually exclusive projects: a. with different IRR's b. of different lengths c. of different sizes d. where the IRR and NPV select different projects e. in all of the above situations 15. Consider a project with an initial investment and positive future cash flows. As the cost of capital increased the a. IRR remains constant while NPV increases. b. IRR decreases while NPV remains constant. c. IRR remains constant while NPV decreases. d. IRR increases while NPV remains constant. e. IRR decreases while NPV decreases. 16. A firm's cost of capital is: a. the cost of raising money to do a particular project b. the average return it pays to investors for the use of their money c. a cost a firm has to pay their shareholders. d. none of the above

Explanation / Answer

12. The answer is "d" - both of the above. There is a possibility of two IRR's when a project has non-conventional cash flows. If a project has an initial negative cash flow (-160,000), followed by a positive cash flow in 1st year (1,000,000) and then again a negative cash flow in the 2nd year (-1,000,000).

IRR will be: -160,000+1,000,000/(1+r)-1,000,000/(1+r)^2 = 0

Solving the above equation will give us 2 IRRs and we will not know which one to use.

Secondly, the assumption that the interim cash flows are reinvested at IRR is wrong. Many a times, there will be a difference in interest rates and there will be several opportunity costs. IRR does not consider these situations.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.