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Explain the Concept Of Internal Rate Of Return (IRR) and explain the methodology’s flaws with mutually...

Explain the Concept Of Internal Rate Of Return (IRR) and explain the methodology’s flaws with mutually exclusive projects and nonconventional cash flows.

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Answer #1

IRR: The rate of return at which NPV become zero. It is a way of evaluating a project .When IRR is greater than WACC then project should be accepted.
Flaws:
1. IRR and NPV may conflict in certain cases of mutually exclusive projects  where NPV rule prevails.
2. IRR rate is higher than WACC generally so reinvestment as higher than WACC may not be possible always.
3. It gives multiple IRR when have more than one negative cash flows occur in the project or non conventional flows. Hence multiple IRR can create confusion.

Assumptions:
1.Reinvestment rate is same as IRR which may not be practical.
2. Two different projects, even if equally risky, have two different reinvestment-rates

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