The correct answer is: D. Discount rate
The internal rate of return (IRR) is a method of capital budgeting that is used to determine the profitability of a project. The IRR is the rate of return that a project must earn in order to break even. It is calculated by finding the discount rate at which the present value of the project’s cash inflows equals the present value of its cash outflows.
The IRR is a useful tool for comparing the profitability of different projects. However, it is important to note that the IRR does not take into account the time value of money. This means that projects with different cash flow patterns may have the same IRR, even though one project is more profitable than the other.
The amount of cash inflows, the life of the project, and the amount of cash outflows are all known variables in the IRR method. The discount rate is the only unknown variable.
Here is a brief explanation of each option:
- A. Amount of cash inflows. The amount of cash inflows is the total amount of money that a project is expected to generate over its lifetime. This includes both revenue and any other sources of income, such as government subsidies.
- B. Life of the project. The life of the project is the length of time that the project is expected to generate cash flows. This can be a fixed number of years or it can be an indefinite period.
- C. Amount of cash outflows. The amount of cash outflows is the total amount of money that a project is expected to spend over its lifetime. This includes both the initial investment and any ongoing costs, such as operating expenses.
- D. Discount rate. The discount rate is the rate of return that is used to calculate the present value of the project’s cash flows. The discount rate is a key factor in determining the IRR. A higher discount rate will result in a lower IRR, and vice versa.