The underlying cause of conflicts in ranking projects by the internal rate of re
ID: 2671295 • Letter: T
Question
The underlying cause of conflicts in ranking projects by the internal rate of return and net present value methods of capital budgeting is:
A. that neither method explicitly considers the time value of money.
B. the assumption made by the IRR method that intermediate cash flows are reinvested at the cost of capital.
C. the assumption made by the NPV method that intermediate cash flows are reinvested at the internal rate of return.
D. the reinvestment rate assumption regarding intermediate cash flows.
Explanation / Answer
Correct answer: D Both the internal rate of return and net present value methods consider time value of money. However, in the IRR method, intermediate cash flows are reinvested at the internal rate of return, while the NPV method assumes intermediate cash flows are reinvested at the cost of capital. It is important to remember that the NPV measure is considered superior because it is a direct measure of the dollar benefit to the shareholder.
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