While net present value (NPV) and internal rate of return (IRR) analysis both may be used as investment decision criteria, there are some limitations to the IRR method that make its use as an investment criterion problematic in certain situations. All of the following are limitations of the IRR method EXCEPT:
A) IRR calculations assume that cash flows are reinvested at the IRR, rather than at the actual rate that investors expected to earn on reinvested cash flows.
B) With the IRR decision criterion multiple solutions may exist for investments where the sign of the cash flows changes more than once over the expected holding period.
C) The IRR methodology cannot be used to make comparisons across different investment opportunities.
D) The use of IRR as a decision criterion will not necessarily result in wealth maximization for the investor.

Question

Quizplus · Accepted Answer

All of the given options are limitations of the IRR method except option C. The IRR method can be used to compare different investment opportunities, but only if those opportunities involve similar cash flow patterns. Therefore, option C is not a limitation of the IRR method. Option A explains that the IRR method assumes reinvestment of cash flows at the IRR, which is not always realistic. Option B explains that the IRR method can be problematic when cash flows change signs multiple times. Option D suggests that IRR may not necessarily result in wealth maximization, which may be a limitation when other investment criteria are considered.

While Net Present Value (NPV) and Internal Rate of Return