Question

Charlie's CelloWorks is considering expanding into other instrument sales. The new investment will require an upfront cost of $100,000. Charlie's is projecting volatile future cash flows as new entries into the musical instrument marketplace are expected to display strong negative correlation with the macro-economy. Due to this, the expected future cash flows for the next four years of the project are: $50,000, $-20,000, $125,000, and $-5,000. Given this project, why might Charlie's not want to use the IRR rule to determine whether or not to make this investment?

A. The IRR rule only works for long-lived projects
B. There could be multiple IRRs
C. The IRR rule does not apply to expansion projects
D. The IRR rule needs to be flipped

Answer 1

B. There could be multiple IRRs

Step-by-step explanation:

IRR is the discount rate that equates the after tax cash flows from an investment to the amount invested.

When cash flow from a project is uneven; that is cash outflow occurs not only at the beginning of the project but also during the lifespan of the project.

In this question, there's a cash outflow in the 2nd and 4th year. This makes IRR and unsuitable method to use.

I hope my answer helps you