Problems with the internal rate of return include ______.

Problems with the internal rate of return include ______.

• A. It can give multiple rates for the same cash flows.
• B. It always aligns with the net present value using the required rate.
• C. It assumes cash flows occur at the end of each period.
• D. It ignores project size entirely.

Answer: (A)

Internal rate of return is the rate that makes a project’s net present value (NPV) equal to zero. The big issue arises when cash flows aren’t conventional—when the signs of the cash flows change more than once. In that situation, the equation used to solve for IRR can have multiple real roots, meaning the same set of cash flows could yield more than one rate that makes NPV zero. This creates ambiguity: which IRR should you use to judge the project, and can lead to conflicting signals about whether to accept it. That’s why the correct statement highlights that IRR can give multiple rates for the same cash flows. For comparison, it’s not guaranteed that IRR always matches NPV at the required rate (they can disagree), and while IRR does assume end-of-period cash flows as a standard modeling simplification, that isn’t the central problem described here. The idea that IRR ignores project size is a separate consideration about scale, not the multiple-rate issue.

Internal rate of return is the rate that makes a project’s net present value (NPV) equal to zero. The big issue arises when cash flows aren’t conventional—when the signs of the cash flows change more than once. In that situation, the equation used to solve for IRR can have multiple real roots, meaning the same set of cash flows could yield more than one rate that makes NPV zero. This creates ambiguity: which IRR should you use to judge the project, and can lead to conflicting signals about whether to accept it.

That’s why the correct statement highlights that IRR can give multiple rates for the same cash flows. For comparison, it’s not guaranteed that IRR always matches NPV at the required rate (they can disagree), and while IRR does assume end-of-period cash flows as a standard modeling simplification, that isn’t the central problem described here. The idea that IRR ignores project size is a separate consideration about scale, not the multiple-rate issue.