Question

Which of the following statements is CORRECT?a. The NPV method assumes that cash flows will be reinvested at the risk-free rate, while the IRR method assumes reinvestment at the IRR.b. The NPV method assumes that cash flows will be reinvested at the cost of capital, while the IRR method assumes reinvestment at the risk-free rate.c. The NPV method does not consider all relevant cash flows, particularly cash flows beyond the payback period.d. The IRR method does not consider all relevant cash flows, particularly cash flows beyond the payback period.e. The NPV method assumes that cash flows will be reinvested at the cost of capital, while the IRR method assumes reinvestment at the IRR.

Answer 1

e. The NPV method assumes that cash flows will be reinvested at the cost of capital, while the IRR method assumes reinvestment at the IRR. Explanation:

Under the NPV method that is the Net Present Value method, discount rate used is cost of capital of a company, that is Weighted Average Cost of Capital. This is to ensure that the company is able to meet its current financing cost.

Under the IRR method the rate is calculated at which the return of investment and cost of such project or investment is equal, if it is more than cost of capital the project is acceptable.

Therefore, statement e stating that the NPV method uses the cost of capital and IRR uses the IRR rate is correct.