CFA Level I · CFA Level I Exam · Capital Investments and Capital Allocation
A project has an unconventional cash flow pattern in which the sign of cash flows changes more than once. Compared with the NPV rule, the IRR rule is most likely to:
The IRR rule is most likely to produce multiple IRRs or no IRR at all, making it unreliable. When cash flows change sign more than once, several discount rates can set NPV to zero, while NPV still gives a clear value at the cost of capital.
- Aproduce multiple IRRs or no IRR, making it unreliableCorrect
- Balways give a higher IRR than the cost of capital
- Cgive the same ranking as NPV for mutually exclusive projects
Explanation
Multiple sign changes can yield several discount rates at which NPV equals zero, or none at all, so the IRR may be ambiguous. NPV remains well defined. The other statements do not follow from unconventional flows.
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