What issue can arise when calculating the internal rate of return (IRR) for projects with non-conventional cash flows?

The internal rate of return (IRR) is a critical metric used in capital budgeting to evaluate the profitability of investments. When a project has non-conventional cash flows—meaning that the cash flows change signs more than once (for example, initial investment is negative, followed by positive cash flows, and potentially another negative cash flow)—this can lead to multiple IRR values being calculated.

This occurrence arises because the IRR is determined by solving the equation that sets the net present value (NPV) of the cash flows equal to zero. If the cash flow signs change multiple times, there are multiple roots to this equation, resulting in different IRR values. This presents a significant challenge for decision-making since it can lead to confusion about which IRR to use when comparing different investment opportunities, making it difficult to ascertain the best project to undertake.

Therefore, the highlighted issue in the correct answer reflects a crucial limitation of using IRR for analyzing projects with complex cash flow patterns, emphasizing the need for careful consideration when interpreting these rates in practical financial scenarios.