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I would like to ask
1. Why we will say by using IRR, we assume the cash flow will be reinvested at internal rate of return? Why it is considered as one of the disadvantages?
2. Why IRR advantage is consider whole life of the projects? Another investment appraisal technique does not do so??
Could sir explain it to me?
Thanks
1. This is only relevant if we are wanting to compare projects using their IRRs, and I explain why in my free lectures. The disadvantage is that it is not normally reasonable to assume that inflows can be reinvested at the IRR.
2. Payback period does not consider the whole life of the project
Do watch my free lectures. They are a complete free courses and cover everything needed to be able to pass the exam well.
I have watched all the free lectures video in F9.
However, the thing that I am not understanding is why we assume inflow can be reinvested at IRR will be considered as disadvantages?
Just to hope to understand the logic behindThanks
You cannot say that a project giving 10% return for 5 years is automatically better than a project giving only 9% but giving it for 20 years.
You could only definitely say that the first project is better if it was giving 10% a year for ever as against 9% a year for ever, and that would only be the case if we were able to reinvest the receipts at 10% or 9%, which is not a reasonable assumption in real life.
In current year, it is reasonsable to consider 10% of IRR rate is good. However, in real life, 10% reinvestment at IRR rate in future year may not be good? maybe future need 20% IRR rate only consider as good?
Thanks sirReinvestment assumptions are only relevant when using IRR to compare two investments. With the reinvestment assumption then the one with the higher IRR is better than the one with the lower IRR, regardless of the cost of capital.
However in the exam we never compare investments using the IRR – what I have written is only relevant for written questions, not for calculations.
ya I am asking for written question. That means reinvestment assumptions are not practical in reality because the rate of return in future may be is 20%. However, IRR assumes the reinvestment rate will be same with IRR which could be only 10%. It is not logically to assume reinvest at 10% (IRR) also in future when the market can actually provide 20% of the reinvestment rate.
Am I correct what i explain above?
Thankss
No. I repeat what I wrote before that the assumption about reinvesting is only relevant if IRR was being use to choose between two projects.
If it is simply a question of accepting or rejecting one project then using IRR to decide would not be a problem (even though in the exam we base the decision on the NPV nd only calculate the IRR if specifically asked to).
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