COST ACCOUNTING
CAPITAL BUDGETING
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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Requires estimate of cost of capital
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May not give value-maximizing decisions for mutually exclusive projects
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May produce multiple IRRs
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Tells whether firm value is increased
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Detailed explanation-1: -Limitations Of IRR It ignores the actual dollar value of comparable investments. It does not compare the holding periods of like investments. It does not account for eliminating negative cash flows. It provides no consideration for the reinvestment of positive cash flows.
Detailed explanation-2: -Multiple Internal Rates of Return: As cash flows of a project change sign more than once, there will be multiple IRRs. NPV is a preferable metric in these cases. When a project has multiple IRRs, it may be more convenient to compute the IRR of the project with the benefits reinvested.
Detailed explanation-3: -If the cash flow stream has one or more cash outflows interspersed with cash inflows, there can be multiple IRRs.
Detailed explanation-4: -The disadvantage of the internal rate of return is that the method does not consider important factors like project duration, future costs, or the size of a project. The IRR simply compares the project’s cash flow to the project’s existing costs, excluding these factors.