424.1
1. Fully explain all of the reasons you should not
use IRR to choose between the following two projects: (2)
| 0 | 1 | 2 | 3 | |
| Project A | -500 | 100 | 400 | |
| Project B | -400 | 300 | 300 | 100 |
-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.