Which statement about IRR and its relation to the required rate of return is true?

• A. It differs because it always uses the same risk as the company.
• B. It is always equal to the weighted average cost of capital (WACC).
• C. It may differ due to non-conventional cash flows, scale, or multiple IRRs.
• D. It ignores the time value of money.

Answer: (C)

Internal rate of return is the discount rate that makes a project’s net present value equal to zero. The required rate of return, or hurdle rate, is the minimum return the firm needs given risk and cost of capital. They’re related but not automatically the same, because IRR reflects only the pattern of the project’s cash flows, not the firm’s risk-adjusted benchmark.

The reason IRR can differ from the required return is most clearly seen with non-conventional cash flows—when signs of the cash flows change more than once. In such cases, the equation for IRR can have multiple real solutions (or none), so you can’t rely on a single IRR to decide if the project meets the hurdle rate. Scale also matters in practice: IRR doesn’t account for project size, so two projects with the same IRR can deliver very different dollar value (NPV) at the firm’s required rate; a larger project with a lower IRR might add more value, while a smaller one with a higher IRR might add less. These issues—multiple IRRs and the impact of cash-flow timing and magnitude—mean the IRR isn’t guaranteed to match the firm’s required return in all situations. D is incorrect because IRR does incorporate the time value of money, and B and A oversimplify what IRR represents.