Final answer:
The false statement is that the IRR decision rule will always identify the correct investment decisions. While IRR is useful, it does not always yield a reliable investment choice compared to the NPV decision rule, especially in the presence of non-standard cash flows or multiple rate of return situations.
Step-by-step explanation:
The statement that is FALSE among the given options is: "Since the IRR rule is based upon the rate at which the NPV equals zero, like the NPV decision rule, the IRR decision rule will always identify the correct investment decisions." The Internal Rate of Return (IRR) rule sometimes fails to identify the correct investment decision in certain scenarios such as non-conventional cash flows or when comparing mutually exclusive projects. It is because the IRR can be misleading in cases where there are multiple IRRs or when the project cash flows are not normal (i.e., the cash flows change sign more than once). In such cases, the NPV decision rule is more reliable.
A financial investor must consider both the rate of return on other available financial investment opportunities, known as the opportunity cost of capital, and a risk premium when valuing future payments. The opportunity cost of capital typically reflects the rate of return the investor forgoes from investing in the next best alternative. If an investment appears riskier than the alternatives, a financial investor would require a higher rate of return to compensate for that increased risk. This example assumes a required rate of 15% set by the investor.
Risks and rates of return are crucial in deciding between different financial investments.
If Investment A becomes riskier, or if its return diminishes, savers may shift their funds to Investment B, and thus the supply curves of financial capital for these investments will adjust accordingly, reflecting the changes in perceived risk and potential returns.