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Discounted cash flow methods and the fallacious reinvestment assumption: a review of recent texts

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  • Stephen Keef
  • Melvin Roush

Abstract

Differences in the assumptions relating to the reinvestment of intermediate cash flows have been offered as the explanation for the conflict that can arise between the net present value method and the internal rate of return method in the ranking of two projects. A review of the literature argues that this assumption is incorrect and thus cannot be an explanation for the conflict. This paper briefly discusses the conflict and presents the results of a survey into the incidence of the assumption in a sample of recent management accounting and finance texts. Seven-tenths of the texts we sampled relied on the fallacious assumption. We offer tentative explanations as to why the fallacious reinvestment assumption is invoked.

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  • Stephen Keef & Melvin Roush, 2001. "Discounted cash flow methods and the fallacious reinvestment assumption: a review of recent texts," Accounting Education, Taylor & Francis Journals, vol. 10(1), pages 105-116.
    • Handle: RePEc:taf:accted:v:10:y:2001:i:1:p:105-116
    DOI: 10.1080/09639280122722
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    References listed on IDEAS

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    1. Dudley, Carlton L, Jr, 1972. "A Note on Reinvestment Assumptions in Choosing Between Net Present Value and Internal Rate of Return," Journal of Finance, American Finance Association, vol. 27(4), pages 907-915, September.
    2. Appleyard, A R & Strong, N C, 1985. "Textbook Inconsistencies in Graphing Valuation Equations: A Note," The Financial Review, Eastern Finance Association, vol. 20(4), pages 361-367, November.
    3. Conine, Thomas E, Jr & Tamarkin, Maurry, 1988. "Textbook Inconsistencies in Graphing Valuation Equations: A Further Note," The Financial Review, Eastern Finance Association, vol. 23(2), pages 237-241, May.
    4. Ezra Solomon, 1956. "The Arithmetic of Capital-Budgeting Decisions," The Journal of Business, University of Chicago Press, vol. 29, pages 124-124.
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    Cited by:

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    2. Kannapiran C. Arjunan & Karthi Kannapiran, 2017. "Cost-benefit Analysis and the Controversial Reinvestment Assumption in IRR and NPV Estimates: Some New Evidence Against Reinvestment Assumption," Economic Papers, The Economic Society of Australia, vol. 36(3), pages 351-363, September.
    3. James F. Oehmke, 2017. "Re‐Examining the Reported Rates of Return to Food and Agricultural Research and Development: Comment," American Journal of Agricultural Economics, John Wiley & Sons, vol. 99(3), pages 818-826, April.
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    5. Graham Bornholt, 2017. "What is an Investment Project's Implied Rate of Return?," Abacus, Accounting Foundation, University of Sydney, vol. 53(4), pages 513-526, December.
    6. Mária Illés, 2016. "The Real Reinvestment Rate Assumption as a Hidden Pitfall," Theory Methodology Practice (TMP), Faculty of Economics, University of Miskolc, vol. 12(01), pages 47-60.

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