Business – 10.3 Investment appraisal – Investment appraisal decisions | e-Consult
10.3 Investment appraisal – Investment appraisal decisions (1 questions)
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Answer:
- Multiple IRRs: Projects with non‑conventional cash‑flow patterns (e.g., an initial outflow followed by a later inflow and then another outflow) can generate more than one IRR, making it unclear which rate should be used for decision‑making.
- Scale of Investment: IRR is a percentage return and does not reflect the absolute size of the expected profit. A small project with a high IRR may add less value than a larger project with a lower IRR but a higher NPV.
- Re‑investment Assumption: IRR assumes that interim cash flows are reinvested at the IRR itself, which is often unrealistic. This can overstate the attractiveness of projects with high IRRs.
- Ranking Mutually Exclusive Projects: When projects are mutually exclusive, the one with the higher IRR may not have the higher NPV, leading to a sub‑optimal choice if the decision is based solely on IRR.