To answer your question about the Internal Rate of Return (IRR), we need to analyze the cash flows provided in each scenario and see if the IRR would lead to potentially misleading investment decisions. The IRR assumes that all cash flows generated by the investment will be reinvested at the same rate as the IRR, which can lead to incorrect conclusions in certain situations.
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Starting cash flow: -100,000 Ending cash flow: 110,000
- This scenario represents an investment of -100,000 with a positive return of 110,000. The IRR would be calculated and is expected to yield a positive return.
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Starting cash flow: -100 Ending cash flow: +200
- Similar to the first scenario, this represents a small investment with a positive return. The IRR is likely positive and also makes financial sense.
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Starting cash flow: 1000 Ending cash flow: -2000
- Here, we start with a positive cash flow of 1,000 and end with a negative cash flow of -2,000. This scenario indicates a loss. The IRR calculation here may yield a negative value or an undefined result (since cash flows start positive and end negative). The IRR would not recommend investing in this opportunity since it represents a loss.
In assessing IRR pitfalls, the most problematic scenario is the last one. The first two provide positive cash returns indicating they are worth considering for investment, while the third cash flow scenario indicates a loss.
Therefore, the answer is:
Starting cash flow: 1000 Ending cash flow: -2000 (This scenario would always lead the IRR to recommend the wrong decision, as it represents a loss.)