honeycfa

Which of the following statements about the internal rate of return (IRR) for a project with the following cash flow pattern is TRUE?

• Year 0: -$ 2,000

• Year 1: $10,000

• Year 2: -$ 10,000

A) It has two IRRs of approximately 38 and 260%.

B) No IRRs can be calculated.

C) It has a single IRR of approximately 38%.

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The number of IRRs equals the number of changes in the sign of the cash flow. In this case, from negative to positive and then back to negative. Although 38% seems appropriate, one should not automatically discount the value of 260%.

Check answers by calculation:

10,000 ÷ 1.38 - 10,000 ÷ 1.38² = 1995.38

And:

10,000 ÷ 3.6 - 10,000 ÷ 3.6² = 2006.17

Both discount rates give NPVs of approximately zero and thus, are IRRs.

honeycfa

If a project has a negative cash flow during its life or at the end of its life, the project most likely has:

A) a negative internal rate of return.

B) more than one internal rate of return.

C) multiple net present values.

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Projects with unconventional cash flows (where the sign of the cash flow changes from minus to plus to back to minus) will have multiple internal rates of return. However, one will still be able to calculate a single net present value for the cash flow pattern.