In terms of evaluating mutually exclusive projects, the internal rate of return (IRR) method may mistakenly favor investment proposals with:
A) Short useful lives.
B) Long useful lives.
C) Moderate cash flow returns.
D) Large residual values.
E) Large initial investment.

Question

Quizplus · Accepted Answer

The IRR method assumes that cash inflows from a project can be reinvested at the same rate as the project's IRR. Therefore, projects with shorter useful lives will have higher IRRs as they generate cash inflows earlier, enabling investors to reinvest the cash sooner. This assumption may be incorrect in reality as it is difficult to find similar investment opportunities with similar IRRs to reinvest the cash. Therefore, the IRR method may mistakenly favor short-lived projects over longer-lived projects, even if the latter is more profitable in the long run.

In Terms of Evaluating Mutually Exclusive Projects, the Internal Rate