Multiple Choice
The goal of financial management is to increase the:
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7. Receivables and Investments
Introduction to Investments in Securities
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The internal rate of return (IRR) method assumes that a project's cash flows are reinvested at the:
A
risk-free rate
B
company's cost of capital
C
weighted average cost of capital (WACC)
D
project's internal rate of return
Verified step by step guidance1
Understand the concept of Internal Rate of Return (IRR): IRR is the discount rate at which the net present value (NPV) of a project's cash flows equals zero. It represents the expected rate of return for the project.
Recognize the reinvestment assumption in IRR: The IRR method assumes that all cash flows generated by the project are reinvested at the project's internal rate of return, which is a key characteristic of this method.
Compare IRR reinvestment assumption with other rates: The IRR method does not assume reinvestment at the risk-free rate, the company's cost of capital, or the weighted average cost of capital (WACC). Instead, it specifically assumes reinvestment at the IRR itself.
Understand why this assumption is important: The reinvestment assumption impacts the accuracy of the IRR method in evaluating projects. If the actual reinvestment rate differs from the IRR, the project's true profitability may vary.
Conclude the correct answer: Based on the IRR method's reinvestment assumption, the project's cash flows are reinvested at the project's internal rate of return, as stated in the problem.
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