Question

On a purely theoretical basis, the NPV is the better approach to capital budgeting due to all the following reasons EXCEPT______.

A) It maximizes shareholder wealth.
B) that there may be multiple solutions for an IRR computation.
C) that it measures the benefits relative to the amount invested.
D) for the reasonableness of the reinvestment rate assumption.

Answer 1

The NPV approach to capital budgeting is not theoretically superior to the IRR due to reason D) the reasonableness of the reinvestment rate assumption because NPV makes no such assumption, while the IRR does, which may not always be realistic.

Step-by-step explanation:

The question pertains to the comparison of different approaches to capital budgeting, specifically Net Present Value (NPV) and Internal Rate of Return (IRR). From the given options, the theoretical reason that is NOT a genuine advantage of NPV over IRR is D) for the reasonableness of the reinvestment rate assumption. NPV is a method that provides a direct measure of the expected increase in value to shareholders and is always based on the same cost of capital. On the other hand, the IRR assumes that all future cash flows can be reinvested at the same rate as the IRR itself, which might not be realistic. Therefore, the reasonableness of the reinvestment rate assumption is not a valid reason that NPV is superior to IRR.

The theoretical advantages of NPV include: A) it maximizes shareholder wealth by directly measuring the expected increase in value, B) there's only a single solution for NPV, avoiding the issue of multiple IRRs, and C) it measures the return relative to the amount invested, providing a clear efficiency metric for the investment.