If the net present value (NPV) of a long term proposal is positive, the internal rate of return is
The correct answer and explanation is:
Correct Answer:
Greater than the required rate of return (or cost of capital).
Explanation:
Net Present Value (NPV) and Internal Rate of Return (IRR) are two major tools used in capital budgeting to evaluate the profitability of long-term investments and projects.
Understanding NPV and IRR:
- Net Present Value (NPV) calculates the difference between the present value of cash inflows and the present value of cash outflows over time. It considers the time value of money and uses a discount rate (usually the company’s required rate of return or cost of capital).
- Internal Rate of Return (IRR) is the discount rate that makes the NPV equal to zero. In other words, it is the rate at which the present value of inflows equals the present value of outflows.
Relationship Between NPV and IRR:
- If the NPV is positive, it means the investment’s return exceeds the discount rate (cost of capital).
- Therefore, the IRR must be greater than the required rate of return. That’s because at a higher rate (the IRR), the project would break even (NPV = 0), but at the lower rate (the cost of capital), the present value of inflows exceeds outflows, resulting in a positive NPV.
Key Takeaway:
A positive NPV means that the project will add value to the company and earn more than the minimum return required. So, the internal rate of return (IRR) must be greater than the discount rate used in the NPV calculation.
Conclusion:
If a long-term investment proposal has a positive NPV, this is a clear indication that the IRR is greater than the required rate of return — making the project financially viable and desirable.