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Sir, in the mock question, provided there’s this question regarding the IRR. It states :
Which of the following is NOT the weakness of IRR in appraising investments
1) it ignores the time value of money
2) there can be several IRR’s for the same investment
3) it is dependent on the cost of capital of the company
4) it cannot be reliably used as a basis for choosing between investmentscan you explain why is the answer statement 2 and 4?
if an investment has several IRR doesn’t that means that it is difficult to make a decision as there’s no perfect IRR? shouldn’t this be accounted as weakness?
Besides, I’m having trouble understanding the below question too. Can you assist me? if gearing ratio is 0.2 does that means that it is 20% debt? hence is equity 80%
James Co had determined the asset beta for the new machine is 1.2 . The gearing ratio (debt to equity) is 0.2. Tax rate 30 %, risk-free 5% and market premium 8 %What is the project specific cost of equity?
2 is not a weakness because if we know what the IRR’s are then we can still determine whether or not a project should be accepted or not because we can still determine from the graph whether the NPV will be positive or negative at the particular cost of capital, and still determine a margin for error in the estimation of the cost of capital.
(You will not be ever asked to calculate multiple IRR’s in the exam).Gearing ratios can be expressed as either debt/equity plus debt; or as debt/equity. The examiner always makes is clear which measure he is using when he gives a gearing ratio.
The project specific cost of equity is the cost of equity applicable to the risk of the project being appraised. It is explained in full in my lectures on Chapter 21 of our free lecture notes.
The lectures are a complete free course for Paper F9 and cover everything needed to be able to pass the exam well.
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