Question

Interim cash inflows are reinvested at a rate of return equal to the internal rate of return, which is the built-in mechanism for:

• A. Net Present Value Method
• B. Internal Rate of Return Method
• C. Profitability Index Method
• D. None of the above

Answer 1

Answer: (B)

Internal Rate of Return Method

Internal rate of return (IRR) is a metric used in capital budgeting to estimate the profitability of potential investments. Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. IRR calculations rely on the same formula as NPV does.

IRR is usually used to calculate the profitability of investments made in a financial product or projects. Higher the IRR, the more profitable it is to invest in a financial scheme or project. Assume all financial products require the same amount of up-front investment, the product with the highest IRR would be considered the best. Of course, one also needs to understand the risk factors before investing