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CS Professional · Strategic Management and Corporate Finance · Project Evaluation

Which assumption about reinvestment of intermediate cash inflows is implicit in the NPV method and in the IRR method respectively?

NPV implicitly assumes interim cash inflows are reinvested at the firm's cost of capital, while IRR assumes they are reinvested at the IRR itself. This is why NPV is seen as more realistic and can rank projects differently from IRR.

  1. ANPV assumes reinvestment at the cost of capital; IRR assumes reinvestment at the IRR itselfCorrect
  2. BNPV assumes reinvestment at the IRR; IRR assumes reinvestment at the cost of capital
  3. CBoth assume reinvestment at the risk-free rate
  4. DBoth assume no reinvestment of inflows

Explanation

NPV discounts flows at the cost of capital, implying interim inflows can be reinvested at that rate, which is realistic. IRR implies reinvestment at the project's own IRR, which can be unrealistic for high-return projects. The reversed option swaps the two assumptions.

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