Which one of the following will occur when the internal rate of return (IRR) equals the required return for an investment in securities?

• A. The payback period will be shorter than the investment's life.
• B. The investment will generate a positive net present value (NPV).
• C. The investment will be rejected automatically.
• D. The net present value (NPV) of the investment will be zero.

Answer: (D)

Verified step by step guidance

1. Understand the concept of Internal Rate of Return (IRR): IRR is the discount rate at which the net present value (NPV) of an investment equals zero. It represents the break-even point for the investment in terms of discounted cash flows.
2. Understand the relationship between IRR and required return: When the IRR equals the required return, it means the investment is expected to generate cash flows that exactly match the investor's required rate of return, resulting in no surplus or deficit in value.
3. Recall the definition of Net Present Value (NPV): NPV is the sum of the present values of all cash inflows and outflows associated with an investment, discounted at the required rate of return. If IRR equals the required return, the NPV will be zero because the cash flows are discounted at the exact rate that equates them to the initial investment.
4. Analyze the options provided: The payback period being shorter than the investment's life is unrelated to IRR and NPV. A positive NPV occurs when the IRR exceeds the required return. Automatic rejection of the investment happens when the IRR is below the required return. Therefore, the correct answer is that the NPV will be zero.
5. Conclude that when IRR equals the required return, the investment neither creates nor destroys value, as the discounted cash flows perfectly offset the initial investment, resulting in an NPV of zero.