33.1
| Year 0 | Year 1 | Year 2 | Year 3 | |
| Project A | -1000 | 500 | 500 | 500 |
| Project B | -800 | 550 | 575 |
1. List and fully explain the reasons you would be reluctant to use IRR to choose between these two projects. You do not have to compute anything to answer this--just explain to me why IRR might give you the wrong answer. (6)
There are 2 problems with IRR here.
-First of all, the projects have different initial investments. Thus, it is inappropriate to use IRR, which is a rate of return, to compare them. The return doesn’t tell me how much value I have added. I’d rather have 10% return on $1 million than 100% return on $1.
-Second, the projects have different lives. Rate of return comparisons do not make sense for projects of different lives since the rates of returns are computed over different periods.
In order to get full credit on this problem,
you had to explain why each reason mattered. For example "Different
initial investments." is not an explanation of why you
wouldn't use IRR. Imagine that your boss said "So what."
and you had to explain why different initial investments were a
problem. Also, the so-called "shotgun approach," where
you put down everything you can think of and hope that some of it
is correct indicates that you don't really know the material and
so will result in a lower score.