medium · Principles of Finance capital-budgeting
Which of the following describes the 'reinvestment rate assumption' difference between NPV and IRR as it relates to the cost of capital?
- The WACC is simply understood as the fixed hurdle rate at which all project profits must eventually be fully distributed back to shareholders as dividends.
- IRR assumes that all intermediate cash flows generated by a project are reinvested at the risk-free rate, which makes it an inherently safer performance metric to use.
- NPV assumes intermediate cash flows are reinvested at the WACC, which is generally more realistic than IRR's assumption of reinvestment at the project's own rate.
- NPV assumes cash flows generated by the project are never reinvested anywhere at all, which is why the resulting figure is denominated purely in today's current dollars.
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