Saturday, February 13, 2010


Reinvestment Assumption and Modified IRR

The net present value (NPV) and internal rate of return (IRR) rules are sometimes assumed to rest on an underlying implicit assumption about reinvestment of the cash flows generated during the lifetime of the project. It is contented that the source of conflict between the two techniques lies in their different reinvestment rates.

The internal rate of return (IRR) method is assumed to imply that the cash flows generated by the project can be reinvestment at its internal rate of return (IRR), whereas the net present value (NPV) method is thought to assume that the cash flows are reinvested at the opportunity cost of capital. Advocates of the reinvestment assumption calculate terminal values of project to prove their point.

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