Fill This Form To Receive Instant Help
Fill This Form To Receive Instant Help
Homework answers / question archive / In what sense is a reinvestment rate assumption embodied in the NPV, IRR, and MIRR methods? What is the assumed reinvestment rate of each method? As a financial officer, you must determine which project your company should accept
In what sense is a reinvestment rate assumption embodied in the NPV, IRR, and MIRR methods? What is the assumed reinvestment rate of each method?
As a financial officer, you must determine which project your company should accept. The projects are mutually exclusive and the net present value (NPV) calculations for each take into account the project's risk. Indicate which project (A or B) you would recommend and explain your reasons for this recommendation.
Project: A
NPV: 3 million dollars
RISK LEVEL: very risky
Project: B
NPV: 2.5 million dollars
RISK LEVEL: very safe
The NPV and IRR methods both involve compound interest and assume that all cash flows received during the intermediate periods is reinvested till the project termination at the reinvestment rate.
Reinvestment rate:
NPV - Cost of capital
IRR - IRR
MIRR - Cost of Capital
2. The discounting rate used to calculate the NPV of a project takes care of the risk involved in the projects. Hence, a project with higher risk uses higher discounted rate whereas a project with lower risk uses lower discounting rate. However, once NPV is calculated, the final choice between the projects is made based on the NPV. Since the NPV of the Project A is higher. Project A should be selected.
