The IRR, NPV and the Fallacy of the Reinvestment Rate Assumptions

The Internal Rate of Return and Net Present Value decision criteria are probably the most well known economic decision criteria: they are also probably the most misunderstood. The ‘reinvestment rate assumptions’ attributed by some writers are two such misconceptions and they appear to be the result of a misunderstanding of two fundamental principles of economic decision making: an economic decision should be (1) based on the prospective differences in the (2) real (out-of-pocket) monetary consequences. This paper illustrates the fallacy of the ‘reinvestment rate assumptions’ numerically, mathematically, and intuitively.