Which of the following statements is correct? One defect of the IRR method vs. t
ID: 2776833 • Letter: W
Question
Which of the following statements is correct?
One defect of the IRR method vs. the NPV is that the IRR does not take account of cash flows over a project’s full life
One defect of the IRR method vs. the NPV is that the IRR does not take account of the time value of money
One defect of the IRR method vs. the NPV is that the IRR does not take account of the cost of capital
One defect of the IRR method vs. 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
One defect of the IRR method vs. the NPV is that the IRR does not take proper account of differences in the sizes of projects
Which of the following statements is correct?
A
One defect of the IRR method vs. the NPV is that the IRR does not take account of cash flows over a project’s full life
BOne defect of the IRR method vs. the NPV is that the IRR does not take account of the time value of money
COne defect of the IRR method vs. the NPV is that the IRR does not take account of the cost of capital
DOne defect of the IRR method vs. 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
EOne defect of the IRR method vs. the NPV is that the IRR does not take proper account of differences in the sizes of projects
Explanation / Answer
Option E Is Correct IRR Methods Ignores the proper account of Difference in the Size of the projects unlike NPV Methods reason is as Fallows
One problem with the IRR is that it ignores the initial investment amount. If you’re comparing two alternative investments and your only decision criteria is the IRR, then which is better – a 50% return on $1,000 investment, or a 10% return on a $50,000 investment? If IRR was your only decision criteria, then you’d choose the first option, ignoring the the size of your initial investment, and therefore the actual cash you’re able receive as a result of your investment.
Another limitation of the IRR is that it doesn’t always equal the return on your initial investment over the holding period. When periodic cash flows exist in an investment that results in capital recovery, the IRR makes no assumptions about what you do with these interim cash flows. For example, you might put that cash flow into a bank account with a much lower yield than the IRR, which can be problematic when evaluating the true return for an investment.
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