1. What is meant by the "reinvestment assumption" and how does this differ between NPV
method and the IRR? What does this difference (if any) mean to the outcome of a specific
project, shareholders and investors in general?
Solution
In the NPV method, the cash flows are assumed to be reinvested at the discount rate
In the IRR method, the cash flows are assumed to be reinvested at the project's own internal rate
of return
The IRR method may lead to multiple IRR's when the project has non-convetional cash flows(
both positive and negative cash flows during the project term) and this may lead to wrongly
accepting or rejecting a project. Again in terms of mutually exclusive projects, The
NPV(reinvestment at dicount rate) may be baised towards long term projects.