Fundamentals of Financial Manageme...
Solutions
Fundamentals of Financial Manageme...
What reinvestment rate assumptions are built into the NPV, IRR, and MIRR methods? Give an explanation for your answer.
To explain: The reinvestment rate assumptions that are built into the NPV, IRR and MIRR methods.
Introduction:
Net Present Value (NPV):
It is a method under capital budgeting which includes the calculation of net present value of the project in which the company is investing. The calculation is done by calculating the difference between the value of cash inflow and value of cash outflow after considering the discounted rate.
Internal Rate of Return (IRR):
It refers to the rate of return that is computed by the company to make a decision regarding the selection of a project for investment. This rate provides the basis for selection of projects with lower cost of capital and rejection of project with higher cost of capital.
Modified Internal Rate of Return (MIRR):
It refers to the rate of return that is computed by the company to make a decision for the selection and ranking of a project for investment. This is a modified version of the IRR with reinvestment of cash flows at the cost of capital.
- Since in the NPV all the calculation is done on the discounted rate considering the time value of money and the discounted rate is the cost of capital, it assumes the reinvestment at the cost of capital.
- Since in IRR all the calculation is done on that discounted rat...
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