Final answer:
The correct option to describe internal rate of return (IRR) is that it may lead to multiple rates when cash flows are not conventional. IRR is used to determine the profitability of investments by identifying the discount rate that makes the NPV of cash flows equal to zero. Multiple rates can occur with non-normal cash flows.
Step-by-step explanation:
The internal rate of return (IRR) option that is correct among the choices given is that it may produce multiple rates of return when cash flows are not conventional. The IRR is a financial metric used to assess the profitability of potential investments. It is the discount rate that makes the net present value (NPV) of all cash flows from a particular project equal to zero. Conventional cash flows typically have one initial cash outflow (the investment) followed by a series of positive cash inflows.
Unconventional or non-normal cash flows, where the project has multiple outflows and inflows over time, can lead to situations where the IRR calculation results in more than one number satisfying the condition of NPV equaling zero, meaning there can be multiple internal rates of return.
An investment's expected rate of return measures its average likely return over time, expressed as a percentage. It takes into account future interest payments, capital gains, or increased profitability. Risk quantifies the uncertainty of achieving the expected profitability, and various types of risk can affect the investment’s return, such as default risk and interest rate risk.