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CS Executive · Corporate Accounting and Financial Management · Capital Budgeting

Which of the following is a recognised limitation of the Internal Rate of Return (IRR) method as taught in capital budgeting?

IRR can produce multiple values when a project's cash flows change sign more than once, such as outflows later in the life. It does use cash flows and recognises time value of money, but non-conventional patterns make the zero-NPV rate ambiguous.

  1. AIt ignores the time value of money
  2. BIt can give multiple IRRs when cash flows change sign more than onceCorrect
  3. CIt cannot be computed for any project with positive cash inflows
  4. DIt uses accounting profit instead of cash flows

Explanation

IRR does consider time value and uses cash flows, so the first and last options are wrong. IRR can be computed for conventional projects. For non-conventional cash flows with more than one sign change, the NPV equation may have several roots, giving multiple IRRs.

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