Final answer:
The rule of thumb of IRR is valid when evaluating investment projects with conventional cash flows that have only one change in direction of cash flows. It becomes less reliable for projects with unconventional cash flows.
Step-by-step explanation:
The rule of thumb of IRR (Internal Rate of Return) is valid when evaluating investment projects with conventional cash flows that have only one change in the direction of the cash flows. In other words, it is valid when the cash flows consist of an initial investment followed by a series of positive cash flows and conclude with a single negative cash flow (or vice versa).
For example, if we have an investment project that requires an initial investment of $10,000 and generates positive cash flows of $2,000 per year for the first four years, followed by a negative cash flow of $7,000 in the fifth year, the rule of thumb of IRR can be applied.
However, the rule of thumb of IRR becomes less reliable and may yield inaccurate results when evaluating investment projects with unconventional cash flows, such as multiple changes in the direction of cash flows or non-conventional timing of cash flows.