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CA Intermediate · Financial Management and Strategic Management · Investment Decisions

Which statement about the Internal Rate of Return (IRR) is correct?

IRR is the discount rate at which a project's NPV equals zero, meaning present value of inflows equals present value of outflows. At that rate the profitability index is one. Average profit over average investment describes the accounting rate of return, not IRR.

  1. AIt is the discount rate at which the NPV of the project is zeroCorrect
  2. BIt is the discount rate at which the payback period equals the project life
  3. CIt is the rate at which the profitability index is zero
  4. DIt is the average accounting profit divided by average investment

Explanation

IRR is defined as the discount rate that equates the present value of cash inflows with the present value of outflows, so NPV equals zero. At IRR the profitability index is 1, not zero. The ratio of average profit to average investment is the accounting rate of return.

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