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The Reinvestment Rate Assumption Fallacy for IRR and NPV: A Pedagogical Note

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  • Magni, Carlo Alberto
  • Martin, John D.

Abstract

The mistaken notion that the internal rate of return (IRR) and net present value (NPV) have required reinvestment rate assumptions built into them was debunked long ago in the academic finance literature. There are no reinvestment rate assumptions built into, or implicit to, the computation and use of either the IRR or NPV. In this brief note, we first review the theoretical underpinnings of the rate of return assumption fallacy and offer two possible origins from the academic finance literature that may have been responsible for the fallacy.

Suggested Citation

  • Magni, Carlo Alberto & Martin, John D., 2017. "The Reinvestment Rate Assumption Fallacy for IRR and NPV: A Pedagogical Note," MPRA Paper 83889, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:83889
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    References listed on IDEAS

    as
    1. 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.
    2. J. Hirshleifer, 1958. "On the Theory of Optimal Investment Decision," Journal of Political Economy, University of Chicago Press, vol. 66(4), pages 329-329.
    3. Ezra Solomon, 1956. "The Arithmetic of Capital-Budgeting Decisions," The Journal of Business, University of Chicago Press, vol. 29, pages 124-124.
    4. 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.
    5. Magni, Carlo Alberto & Veronese, Piero & Graziani, Rebecca, 2017. "Chisini means and rational decision making: Equivalence of investment criteria," MPRA Paper 81532, University Library of Munich, Germany.
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    internal rate of return; reinvestment rate; NPV; MIRR;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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