Sir, Could you please explain the concept of cash flows being reinvested at IRR while using IRR.
As far as I understand, IRR is supposed to provide a point to which the cost of capital can increase beyond which the project would not be worthwhile.
So then why do we look at reinvestment of the cash inflows?
Thanks.
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IRR
8y ago#1It is only relevant when comparing projects. If comparing projects it is not valid to simply choose the one with the higher IRR (because the IRR is simply the rate of interest at which the NPV is zero) - we should choose the one with the highest NPV.
However, if it were the case that inflows were to be continually re-invested at the IRR, then (and only then) the one with the highest IRR would be the best.
It is really not until P4 that this becomes an issue, which is why there is something called the MIRR (modified IRR), but that it not examinable in Paper F9.
So, this means that if the projects are in perpetuity, or the project can be invested in again indefinitely immediately after the project ended (With same cash flows), then we should use IRR for comparison?
8y ago#3Yes, but that will never be the case in exam questions.
The relevance for the exam is only for written parts of questions.
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