Question

30) Internal Rate of Return is a tool Financial Analysts use to determine whether to accept or reject a potential project the firm is considering. It is defined as:

Multiple Choice

• the discount rate that results in a zero net present value (NPV) for the project.

• the discount rate that results in a net present value (NPV) equal to the project's initial cost.

• the discount rate that causes a project's after-tax income to equal zero.

• the rate of return required by the project's investors.

• the project's current market rate of return.

Answer 1

Answer : Correct Option is the discount rate that results in a zero net present value (NPV) for the project.

Reason :

IRR is the discount rate at which present value of cash inflow is equal to present value of cash outflow, thus making Net present value zero. The IRR is to be obtained by hit and trial method to ascertain the discount rate at which , present value of cash inflow equals to present value of cash outflow.The use of IRR , as criterion to accept capital investment decision involves comparision of IRR with the required rate of return known as cut off rate . If IRR is greater than the cut off rate , the project should be accepted. If IRR is less than the cut off rate, the project is rejected. If IRR is equal to the cut off rate , the firm is indifferent.