Which statement best describes when IRR can be misleading?

• A. NPV ignores the time value of money.
• B. IRR is always preferred to NPV in all projects.
• C. NPV uses a discount rate to calculate value; IRR is the rate that makes NPV zero; IRR can be misleading with non-conventional cash flows or multiple IRRs; assumes reinvestment at IRR.
• D. IRR ignores timing.

Answer: (C)

The main idea is that the internal rate of return can be misleading in certain cash-flow patterns and due to its reinvestment assumption. IRR is the discount rate that makes the project’s net present value zero, which implicitly assumes that all interim cash inflows can be reinvested at the same rate. When cash flows are non-conventional—changing sign more than once—you can get multiple IRRs or no IRR at all, which makes the single IRR figure ambiguous and potentially misrepresentative of the project's true value. Because of that, relying on IRR alone can lead to incorrect decisions, especially when comparing projects of different sizes or timelines.

In contrast, net present value translates all future cash flows into present value using a specified discount rate (usually the cost of capital) and provides a direct measure of added value. A statement asserting that a key limitation of IRR is its non-standard cash flows or multiple IRRs, along with the unrealistic reinvestment assumption at the IRR, best captures when IRR can be misleading.

As for the other ideas: NPV does account for the time value of money, so saying it ignores it is not correct; IRR is not always the preferred method over NPV in all projects, especially when projects have different scales or non-conventional cash flows; and IRR does not ignore timing—it depends on when cash flows occur, which is part of why its reinvestment assumption can distort its usefulness.