Question

Which of the following statements is CORRECT?a. One defect of the IRR method is that it does not take account of the time value of money.b. One defect of the IRR method is that it does not take account of the cost of capital.c. One defect of the IRR method is that it values a dollar received today the same as a dollar that will not be received until sometime in the future.d. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.e. One defect of the IRR method is that it does not take account of cash flows over a project's full life.

Answer 1

Answer:

d. One defect of the IRR method is that it assumes that the cash flows to be received from a project can be reinvested at the IRR itself, and that assumption is often not valid.

Explanation:

While calculating a project's IRR, that is internal rate of return we calculate the return at which the outflow = inflow. Further it is assumed that the funds will be reinvested at the same rate.

As with change in weights because of amount invested, change in capital structure,  the effective rate also changes, and the expected rate of return being IRR is generally not the same.

Accordingly, this is a correct statement that most of the times it is not true that reinvestment will earn the same rate of return as of IRR.