Final answer:
When comparing two mutually exclusive projects using IRR, project size can cause issues as IRR does not account for the scale of the investment or returns, potentially misleading comparisons if not considered alongside other factors like absolute returns.
Step-by-step explanation:
The issue when comparing two mutually exclusive projects using IRR (Internal Rate of Return) typically arises from the project size difference. A project's IRR doesn't take into account the absolute size of the investment or the returns. Therefore, a project with a smaller initial investment might have a higher IRR compared to a larger project that actually delivers more net cash inflows, thus leading to potential misinterpretations when simply comparing IRRs.
Project duration can also affect comparisons because IRR assumes reinvestment of the cash inflows at the project's own IRR. If one project is much longer than another, this assumption may become unrealistic or inappropriate. The profitability index is related to NPV (Net Present Value) and not typically a direct cause of issues in IRR comparisons, whereas the project discount rate is used in the NPV method and not directly relevant in calculating or comparing the IRR.