Question

question 10 (5 points)
listen
which of the following statements is correct?
one defect of the irr method is that it does not take account of cash flows over a project’s full life.
one defect of the irr method is that it does not take account of the time value of money.
one defect of the irr method is that it does not take account of the cost of capital.
one defect of the irr method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future.
one defect of the irr method is that it assumes that the cash flows to be received from a project can be reinvested at the irr itself, and that assumption is often not valid.

Explanation:

To determine the correct statement about the Internal Rate of Return (IRR) method:

• The first option is incorrect because IRR does consider cash flows over the project’s full life.
• The second option is incorrect because IRR does account for the time value of money (it discounts cash flows).
• The third option is incorrect because the cost of capital is relevant in comparing with IRR, but “not taking account of it” is not a core defect of IRR itself (IRR calculates a rate, while the cost of capital is a separate benchmark).
• The fourth option is incorrect because IRR does discount future cash flows, so it does not value a future dollar the same as a present dollar.
• The fifth option is correct: A key defect of IRR is its reinvestment assumption (that cash flows are reinvested at the IRR), which is often unrealistic.

Answer:

The correct statement is: One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid. (The option with this statement)