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The two fatal flaws of the internal rate of return rule are     A. arbitrary determination of...

The two fatal flaws of the internal rate of return rule are

    A. arbitrary determination of a discount rate and failure to consider initial expenditures.

    B. arbitrary determination of a discount rate and failure to correctly analyze mutually

       exclusive investment projects.

    C. arbitrary determination of a discount rate and the multiple rate of return problem.

    D. failure to consider initial expenditures and failure to correctly analyze mutually

      exclusive investment projects.

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Answer #1

C. arbitrary determination of a discount rate and the multiple rate of return problem.

Internal rate of return (IRR) has an unrealistic assumption that the project cashflows can be reinvested at IRR, which is not possible. They can be reinvested at firm's cost of capital. This is the arbitrary determination of discount rate.

There is one more drawback in IRR. In some instances, we arrive at multiple IRRs, which is multiple rate of return problem. Because of these drawbacks, IRR is not a good investment criteria.

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