Which metric calculates the rate of return that makes Net Present Value equal to zero?

Which metric calculates the rate of return that makes Net Present Value equal to zero?

• A. Internal Rate of Return
• B. Net Present Value
• C. Payback Period
• D. Accounting Rate of Return

Answer: (A)

The concept being tested is the rate of return that makes the net present value of a project zero. The Internal Rate of Return is defined as the discount rate that sets the present value of all future cash inflows equal to the initial investment, so the NPV becomes zero. In other words, you’re solving for the yield r in the equation that discounts all cash flows to match the upfront outlay. This rate is useful because you can compare it to your required return or cost of capital to decide whether to proceed. The other metrics measure different ideas: net present value is the value of the project at a given discount rate; the payback period focuses on how long it takes to recover the initial investment and ignores time value after that; the accounting rate of return uses accounting profits rather than cash flows and also ignores the time value of money. So the metric that specifically yields the rate that makes NPV zero is the Internal Rate of Return.

The concept being tested is the rate of return that makes the net present value of a project zero. The Internal Rate of Return is defined as the discount rate that sets the present value of all future cash inflows equal to the initial investment, so the NPV becomes zero. In other words, you’re solving for the yield r in the equation that discounts all cash flows to match the upfront outlay. This rate is useful because you can compare it to your required return or cost of capital to decide whether to proceed. The other metrics measure different ideas: net present value is the value of the project at a given discount rate; the payback period focuses on how long it takes to recover the initial investment and ignores time value after that; the accounting rate of return uses accounting profits rather than cash flows and also ignores the time value of money. So the metric that specifically yields the rate that makes NPV zero is the Internal Rate of Return.