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Hello,
I often read as a criticism of irr that it assumes cash-flows are re-invested at the irr but I’ve never really understood what this means, could you possibly explain further please?
Thanks,
AlexIt is relevant when projects are being compared with each other.
Suppose 10,000 in invested in one project that last for 5 years and has an IRR of 10% and an alternative is to invest in another project that lasts for 10 years but has an IRR of 9%.
You cannot automatically say that the project with the IRR of 10% is better – the better one is the one with the highest NPV, which could well be the second one because although the returns are a little less, they would be getting them for much longer.
However, if the returns from both projects could be reinvested at their IRR’s, then certainly the first project would be the better one because they would be effectively be getting 10% for ever which would obviously be better than getting 9% for ever 🙂
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