Certified Management Accountant Practice Exam

How does the IRR impact investment decisions if it is higher than the desired rate of return?

1. It makes the investment less attractive.

2. It indicates a commonly accepted investment.

3. It suggests the investment is desirable.

4. It disqualifies the investment option.

The correct answer is: It suggests the investment is desirable.

When the Internal Rate of Return (IRR) of an investment exceeds the desired rate of return, it implies that the investment is expected to generate returns that surpass the benchmark or threshold that an investor has set for acceptable performance. This is a strong signal that the investment is likely to be profitable and aligns with the investor's financial goals. The IRR is essentially the rate at which the net present value of an investment's cash flows equals zero, making it a critical determinant in evaluating potential investments. If this rate is higher than what the investor aims to achieve, it reinforces confidence in the viability of the investment, suggesting that it will generate value beyond the minimum requirement. Hence, it positions the investment as a desirable option for capital allocation, as it suggests potential for higher profits and an overall positive impact on investment return metrics. In contrast, options that indicate less desirability or potential disqualification do not align with the rationale behind the IRR exceeding the desired rate of return. The framework for investment decision-making supports the idea that higher IRR translates to greater appeal, making option C the most accurate representation of the scenario.