Internal Rate of Return question, increase, capital, including, percentage

fructify

The text states: The IRR rule uses the opportunity cost of capital as the rate that a project's IRR must exceed for the project to be accepted.

Then a question asks: How will the IRR change if opportunity cost of capital were to increase by 5 percentage points.
Yet the answer says: The IRR is unaffected by any change in any external rate, including the increase in opportunity cost of capital.

First, isn't a company's opportunity cost of capital an internal rate? More importantly, why is the IRR unaffected when the text says the IRR rule uses the opportunity cost of capital?

scr879

Nevermind - I think I got it. IRR is not calculated based on the opportunity cost of capital; it's just compared to it. So, if the opportunity cost of capital increases, IRR is unchanged, though the analysis of the IRR rule changes because IRR may not exceed the new op cost of capital.

Right?

dmar

you are correct, yes. IRR is used as a benchmark for project acceptance decisions.



Edited 1 time(s). Last edit at Thursday, May 5, 2011 at 10:15PM by BayStreet.

kasinkei

"IRR is the hurdle rate. If IRR and NPV conflict, use NPV. But I know you're not asking that.

Just wanted to sound smart. Thank you."

- thanks for the laugh