Question

Which of the following statements are true for Internal Rate of Return (IRR)?
(A) In computation of internal rate of return, the time value of money is accounted.
(B) IRR is known as marginal efficiency of capital.
(C) IRR is the discount rate at which the present values of net cash flows are just equal to zero.
(D) IRR is also defined as the ratio of net present values of the cash flows to the initial capital expenditure.
Choose the correct answer from the options given below:

• A. (B) and (C) only.
• B. (A) and (C) only.
• C. (A), (B) and (C) only.
• D. (B), (C) and (D) only.

Hint:

Remember the defining rule: IRR is the exact discount rate at which Net Present Value (NPV) is equal to zero (NPV = 0). This identifies statement (C) as correct.

Answer 1

The Correct Option is C

Step 1: Understanding the Concept:
The Internal Rate of Return (IRR) is a metric used in capital budgeting to assess the profitability of investments. It is a discounted cash flow method that accounts for the timing of cash flows.
Detailed Explanation:
Let us analyze each statement:
- (A) In computation of internal rate of return, the time value of money is accounted: IRR is a discounted cash flow method, meaning it accounts for the time value of money by discounting future cash flows. This statement is true.
- (B) IRR is known as marginal efficiency of capital: Economically, the Marginal Efficiency of Capital (MEC) is defined as the rate of discount that equates the present value of expected returns to the asset's supply price. This is conceptually identical to the IRR, making this statement true.
- (C) IRR is the discount rate at which the present values of net cash flows are just equal to zero: By definition, the IRR is the discount rate ($r$) that makes the Net Present Value (NPV) of a project equal to zero. This statement is true.
- (D) IRR is also defined as the ratio of net present values of the cash flows to the initial capital expenditure: This describes the Profitability Index (PI) or Benefit-Cost Ratio, not the IRR. This statement is false.
Therefore, statements (A), (B), and (C) are true.

Step 2: Final Answer:
This matches Option (C).