What is a primary concern regarding internal rate of return (IRR) when valuing acquisitions?

What is a primary concern regarding internal rate of return (IRR) when valuing acquisitions?

• A. IRR fluctuates with market conditions
• B. IRR may underestimate project value
• C. IRR could fluctuate based on cash flow timing
• D. IRR cannot handle variable project sizes

Answer: (C)

The primary concern regarding internal rate of return (IRR) when valuing acquisitions is that IRR could fluctuate based on cash flow timing. This is significant because IRR is highly sensitive to the timing of cash flows, which means that small changes in the timing can lead to substantial changes in the calculated IRR. If cash inflows are received sooner, the IRR will typically be higher, whereas delays in cash inflows can reduce the IRR. This sensitivity can make IRR an unreliable metric when comparing projects with different cash flow timings, complicating decision-making in acquisitions. While other factors like market conditions or project sizes can also affect valuation assessments, the core issue with IRR lies in its reliance on when cash flows are expected to occur, which directly impacts the resulting rate of return calculation. Thus, understanding the timing of cash flows is crucial when making investment decisions based on IRR.

The primary concern regarding internal rate of return (IRR) when valuing acquisitions is that IRR could fluctuate based on cash flow timing. This is significant because IRR is highly sensitive to the timing of cash flows, which means that small changes in the timing can lead to substantial changes in the calculated IRR. If cash inflows are received sooner, the IRR will typically be higher, whereas delays in cash inflows can reduce the IRR. This sensitivity can make IRR an unreliable metric when comparing projects with different cash flow timings, complicating decision-making in acquisitions.

While other factors like market conditions or project sizes can also affect valuation assessments, the core issue with IRR lies in its reliance on when cash flows are expected to occur, which directly impacts the resulting rate of return calculation. Thus, understanding the timing of cash flows is crucial when making investment decisions based on IRR.