Which of the following is/are true?
I. The IRR method assumes that future cash flows are reinvested at the project's cost of capital.
II. The NPV method assumes that future cash flows are reinvested at the project's cost of capital.
III. The MIRR method assumes that future cash flows are reinvested at the project's cost of capital.
IV. MIRR and NPV methods always lead to the same decisions for projects of similar sizes.
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A. B. C. D. E. F. G. H.A
The IRR method assumes that future cash flows are reinvested at the internal rate of return of the project, not the project's cost of capital. Statements (II), (III) and
(IV) are true.
Let's analyze each statement one by one:
I. The IRR method assumes that future cash flows are reinvested at the project's cost of capital.
This statement is true. The internal rate of return (IRR) is the discount rate at which the net present value (NPV) of an investment becomes zero. It assumes that all future cash flows generated by the project will be reinvested at the project's cost of capital. In other words, the IRR assumes that the cash flows earned from the project can be reinvested at the same rate of return as the project itself.
II. The NPV method assumes that future cash flows are reinvested at the project's cost of capital.
This statement is true. The net present value (NPV) method calculates the present value of cash inflows and outflows associated with an investment project, using the project's cost of capital as the discount rate. The NPV assumes that all future cash flows generated by the project will be reinvested at the project's cost of capital.
III. The MIRR method assumes that future cash flows are reinvested at the project's cost of capital.
This statement is false. The modified internal rate of return (MIRR) method assumes that cash inflows from a project are reinvested at the firm's reinvestment rate, which may differ from the project's cost of capital. The MIRR takes into account both the rate at which cash flows are reinvested and the rate at which cash flows are financed.
IV. MIRR and NPV methods always lead to the same decisions for projects of similar sizes.
This statement is false. MIRR and NPV methods may not always lead to the same decisions for projects of similar sizes. The MIRR method incorporates the firm's reinvestment rate, which could be different from the project's cost of capital. On the other hand, the NPV method uses the project's cost of capital as the discount rate. Therefore, depending on the reinvestment rate and the project's cost of capital, the MIRR and NPV methods can yield different investment decisions for projects.
Based on the analysis, the correct answer is:
G. II & IV