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IAI Actuarial Core Principles · Business Finance · Cost of capital and evaluating investment projects

Which statement about the internal rate of return (IRR) of a conventional project is correct?

IRR is the discount rate at which the NPV of the project's cash flows is zero. A project is acceptable if its IRR exceeds the required return. The accounting rate of return is a different measure based on profits, not discounted cash flows.

  1. AIt is the discount rate at which the project's NPV equals zeroCorrect
  2. BIt is the discount rate at which the project's NPV is maximised
  3. CIt equals the company's weighted average cost of capital
  4. DIt is the accounting profit divided by the average capital employed
  5. It is the rate at which the payback period equals the project life

Explanation

IRR is defined as the discount rate that makes the present value of inflows equal the present value of outlays, so NPV is zero. Accounting profit over capital employed describes ARR, not IRR. IRR is compared with the cost of capital but is not equal to it.

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