IDEAS home Printed from https://ideas.repec.org/p/sek/itepro/3906612.html
   My bibliography  Save this paper

Teaching about the reinvestment rate assumption and conflicts in Capital Budgeting

Author

Listed:
  • Sorin Tuluca

    (Fairleigh Dickinson University)

Abstract

Much has been written in finance textbooks and scholarly publications about the capital budgeting methods derived from Discount Cash Flow (DCF) models: Net Present Value (NPV), Internal Rate of Return (IRR), Modified Internal Rate of Return (MIRR) and Profitability Index (PI). However, there is a divergent understanding about the role of the reinvestment rate assumption in some of these models. In this paper I will discuss a number of issues regarding the assumption of the reinvestment rate and clarify its correct usage. This discussion will naturally lead to the Modified Internal Rate of Return as the only method where a reinvestment rate assumption makes sense. In addition, for the first time in the literature I will propose a method of determining if the NPV and MIRR will produce conflicting decisions in advance of the MIRR computation. The literature has a clear method to determine if the there is a conflict between NPV and IRR but no method for the NPV-MIRR conflict is described. Interestingly the Profitability Index will have a role in determining if the NPV and MIRR are in conflict. The paper is useful to all those who teach the topic of capital budgeting in corporate finance courses of any level.

Suggested Citation

  • Sorin Tuluca, 2016. "Teaching about the reinvestment rate assumption and conflicts in Capital Budgeting," Proceedings of Teaching and Education Conferences 3906612, International Institute of Social and Economic Sciences.
    • Handle: RePEc:sek:itepro:3906612
    as

    Download full text from publisher

    File URL: https://iises.net/proceedings/3rd-teaching-education-conference-barcelona/table-of-content/detail?cid=39&iid=022&rid=6612
    File Function: First version, 2016
    Download Restriction: no
    ---><---

    Other versions of this item:

    More about this item

    Keywords

    Capital Budgeting; reinvestment rate; conflict in ranking;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:sek:itepro:3906612. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no bibliographic references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Klara Cermakova (email available below). General contact details of provider: https://iises.net/ .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.