Answer to Question #19483 in Economics for allan

Question

Which of the following statements is CORRECT?


Projects with “normal” cash flows can have only one real IRR.








Projects with “normal” cash flows can have two or more real IRRs.








Projects with “normal” cash flows must have two changes in the sign of the cash flows, e.g., from negative to positive to negative. If there are more than two sign changes, then the cash flow stream is “nonnormal.”








The “multiple IRR problem” can arise if a project’s cash flows are “normal.”








Projects with “nonnormal” cash flows are almost never encountered in the real world

Answer 1

Statement of "Projects with “normal” cashflows can have only one real IRR" is CORRECT. A project has normal cash flows when the initial cash flow is negative, and all other cash flows are
positive, so IRR is the discount rate often used in capital budgeting that
makes the net present value of all cash flows from a particular project equal
to zero. Generally speaking, the higher a project's internal rate of return,
the more desirable it is to undertake the project. As such, IRR can be used to
rank several prospective projects a firm is considering. Assuming all other
factors are equal among the various projects, the project with the highest IRR
would probably be considered the best and undertaken first.