Which statement describes a key limitation of Internal Rate of Return (IRR) when used as an investment appraisal method?

• A. IRR ignores the time value of money.
• B. It can yield multiple IRRs for non-normal cash flows.
• C. It always requires a positive NPV to be acceptable.
• D. It is unaffected by the scale of the investment.

Answer: (B)

The limitation shown here arises when cash flows aren’t conventional, meaning they change sign more than once. IRR is the discount rate that makes the net present value of all cash flows equal to zero. If the project has multiple sign changes, the equation can cross zero at more than one rate, giving several IRRs. That creates ambiguity: which IRR should you use to judge the project? Because the same set of cash flows can produce different IRRs, relying on IRR alone can lead to conflicting signals about whether to proceed.

To handle this, analysts often turn to net present value at the firm’s cost of capital or use a modified IRR, which yields a single, consistent rate by changing how reinvestment is treated. The other statements aren’t accurate because IRR does reflect the time value of money, and acceptance rules are typically based on IRR relative to a hurdle rate rather than a blanket positive NPV requirement. Also, while scale can influence the attractiveness of a project, the core issue here is the potential for multiple IRRs with non-normal cash flows.