Answer (C) is correct . Investment projects may be mutually exclusive under conditions of capital rationing (limited capital). In other words, scarcity of resources will prevent an entity ? from undertaking all available profitable activities. Under the IRR method, an interest rate is computed such that the present value of the expected future cash flows equals the cost of the investment (NPV = 0). The IRR method assumes that the cash flows will be reinvested at the IRR. The NPV is the excess of the present value of the estimated net cash inflows over the net cost of the investment. The cost of capital must be specified in the NPV method. An assumption of the NPV method is that cash flows from the investment will be reinvested at the particular project’s cost of capital. Because of the difference in the assumptions regarding the reinvestment of cash flows, the two methods will occasionally give different answers regarding the ranking of mutually exclusive projects. Moreover, the IRR method may rank several small, short-lived projects ahead of a large project with a lower rate of return but with a longer life span. However, the large project might return more dollars to the company because of the larger amount invested and the longer time span over which earnings will accrue. When faced with capital rationing, an investor will want to invest in projects that generate the most dollars in relation to the limited resources available and the size and returns from the possible investments. Thus, the NPV method should be used because it determines the aggregate present value for each feasible combination of projects.
Answer (A) is incorrect because The IRR is a number computed based on the characteristics of a given project.
Answer (B) is incorrect because Cash flows are discounted under the IRR method.
Answer (D) is incorrect because An accelerated depreciation method will generate larger net cash inflows in the early years of a project. To equate the present value of these cash flows with the net investment will therefore require a higher discount rate (IRR).
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