If a project has multiple internal rates of return (IRRs), which of the following methods should be used to evaluate the project's profitability?

• A. Modified Internal Rate of Return (MIRR) method
• B. Net Present Value (NPV) method
• C. Accounting Rate of Return (ARR) method
• D. Payback Period method

Answer: (B)

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 cash flows equals zero. Multiple IRRs can occur when a project's cash flows change direction (e.g., from positive to negative) more than once.
2. Recognize the limitation of IRR: When there are multiple IRRs, it becomes difficult to determine the project's profitability using IRR alone, as it can lead to conflicting results.
3. Learn about the Net Present Value (NPV) method: NPV calculates the present value of all cash inflows and outflows using a single discount rate (usually the cost of capital). It provides a clear measure of profitability by showing the net value created by the project.
4. Compare NPV to other methods: While methods like Modified Internal Rate of Return (MIRR), Accounting Rate of Return (ARR), and Payback Period have their uses, NPV is considered the most reliable method for evaluating profitability, especially when IRR is ambiguous.
5. Conclude that the NPV method should be used: Since NPV avoids the issue of multiple IRRs and directly measures the value added by the project, it is the preferred method for evaluating profitability in this scenario.