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1. Why would the average rate of return differ from the internal rate of return on the same project? 2. What would yo...

1. Why would the average rate of return differ from the internal rate of return on the same project?

2. What would you use to evaluate an investment opportunity?

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Answer #1

1. Average rate of return is calcuted by dividing net income by average invsement whereas internal rate of return is the rate at which the present value of the cash flows is NIL. they both differ because of the 2 reasons which are as follows -

a) only net income is considered in the calculation of average rate of return whereas internal rate of return uses cash flows.

b) internal rate of return takes into account time value of money whereas average rate of return ignores it.

2. We would use internal rate of return to evaluate an investment opportunity because it uses actual cash flows instead of net income and it also gives importance to the time value of money.

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