The Real Reinvestment Rate Assumption as a Hidden Pitfall


  • Mária Illés University of Miskolc



reinvestment rate assumption, net present value, internal rate of return, orthodox and unorthodox cash flow pattern, ranking, aggregate capital needs


The paper explores a few hidden problems of the reinvestment rate assumption. The automatism of net present value method creates and applies a very special reinvestment rate assumption. This assumption does not disturb the evaluation of investment projects with orthodox cash flow patterns. However, in the case of unorthodox cash flow patterns, automatism constructs a serious mistake in the calculations. In this case, the net present value provides wrong information about the economic efficiency. However, according to the general academic opinion, the net present value method is suitable for evaluation in the case of unorthodox cash flow patterns as well, as there can be only one net present value as opposed to the opportunity of several internal rates of return. The paper sets out to prove that this way of evaluation is wrong, and works out a solution based on the real economic basis.

Author Biography

Mária Illés, University of Miskolc



ALCHIAN, A. A. (1955): The Rate of Interest, Fisher's Rate of Return over Costs and Keynes' Internal Rate of Return. American Economic Review. Vol. 45, No.5, 938-943. ARNOLD, J. & HOPE, T. (1990): Accounting for Management Decisions. (Second edition.) Prentice Hall International (UK) Ltd. London.

BIERMAN, H., JR. & SMIDT, S. (2012). The Capital Budgeting Decision: Economic Analysis of Investment Projects (9th ed.) Routledge.

BREALEY, R. A. & MYERS, S. C. (1988): Principles of Corporate Finance. (Third edition.) McGraw-Hill Publishing Company. New York.

CARLSON, C. R., LAWRENCE, M.L. & WORT, D.H. (1974): Clarification of the Reinvestment Assumption in, Capital Analysis. Journal of Business Research, Vol. 2, No. 2, (April) pp. 201-208.

CREAN, M. J. (2005): Point of View. Revealing the True Meaning of the IRR via Profiling the IRR and Defining the ERR. Journal of Real Estate Portfolio Management. Vol. 11, No. 3, pp. 323-330.

DUDLEY, C. L., JR. (1972): A Note on Reinvestment Assumptions in Choosing between Net Present Value and Internal Rate of Return. The Journal of Finance. Vol. 27, No. 4 (Sep.), pp. 907-915.

FIRER, C. & GILBERT, E. (2004): Investment Basics XLVIII. Common challenges in capital budgeting. Investment Analysts Journal, No. 59. pp. 41-45.

FISHER, I. (1930): The Theory of Interest. Macmillan. ILLÉS, M. (2007): Scientific Problems of Modern Approach of Net Present Value. Theory Methodology Practice: Club of Economics in Miskolc. Vol. 4, Nr. 1, pp. 29-35.

ILLÉS, M. (2012a): Transforming the Net Present Value for a Comparable One. Theory Methodology Practice: Club of Economics in Miskolc. Vol. 8, Nr. 1, pp. 24-32. ILLÉS, M. (2012b): Links Between Net Present Value and Shareholder Value form a Business Economics Perspective. Theory Methodology Practice: Club of Economics in Miskolc. Vol. 8, Nr. 2, pp. 31-36.

ILLÉS, M. (2014) Fisher's Rate and Aggregate Capital Needs in Investment Decisions. Theory Methodology Practice: Club of Economics in Miskolc. Vol. 10, Nr. 1, pp. 21-32.

ILLÉS M. (2015): Az aggregált tőkeigény gyors becslésének lehetősége a belső kamatláb esetén. (Possibility of a Quick Estimation of Aggregate Capital Needs in Case of Internal Rate of Return.) „Mérleg és Kihívások” IX. Nemzetközi Tudományos Konferencia. Miskolc: Miskolci Egyetem Gazdaságtudományi Kar, 2015. 948 p. JOHNSTON, K. - FORBES, S. - HATEM, J. J. (2002): Reinvestment Rate Assumptions in Capital Budgeting: A Note. Journal of Economics and Finance Education. Vol. 1, No 2, pp. 28-29.

KEANE, S.M. (1975): Investment selection criteria: an examination of the theory of the internal rate of return and of the investment discount rate under conditions of uncertainty. PhD thesis. University of Glasgow.

KEANE, S.M. (1979): The Internal Rate of Return and the Reinvestment Fallacy. Abacus Vol.15, No. 1, pp. 48-55. KEEF, S.P. & ROUSH, M.L. (2001): Discounted Cash Flow Methods and the Fallacious Reinvestment Assumption: A Review of Recent Texts. Accounting Education. Volume: 10 Issue: 1 (Mar), pp.105-116.

LAUX, J. (2011) Topics In Finance Part VI – Capital Budgeting. American Journal of Business Education. Volume 4, Number 7 pp. 29-38

LOHMANN, J.R. (1988): The IRR, NPV and the Fallacy of the Reinvestment Rate Assumptions. The Engineering Economist. Volume 33, Issue 4 pp. 303-330

MEYER, R.L. (1979): A Note on Capital Budgeting Techniques and the Reinvestment Rate. The Journal of Finance. Vol. 34, No. 5 (Dec.), pp. 1251-1254.

MAO, J.C.T. (1969): Quantitative Analysis of Financial Decisions. Macmillan.

PLATH, D. H. A. & KENNEDY, W. F. (1994): Teaching return-based measures of project evaluation. Financial Practice & Education, (Spring/Summer), 77-86.

RENSHAW, E. (1957): A Note on the Arithmetic of Capital Budgeting Decisions. Journal of Business. Vol. 30, No. 3 (July), pp. 193–201.

RICH, S. P. & ROSE, J. T. (2014): Re-Examining an Old Question: Does the IRR Method Implicitly Assume a Reinvestment Rate? Journal of Financial Education. Vol.10, No.1, pp. 105-116

SCHAFRICK, I.C. (2003): Analyzing multiple internal rates of return. Theses and Dissertations. Paper 804. Lehigh University.

SOLOMON, E. (1956): The Arithmetic of Capital Budgeting Decisions. Journal of Business. Vol. 29, No. 2 (April), pp. 124–29.

VAN HORNE, J. C. & WACHOWICZ, J. M., JR. (2008): Fundamentals of Financial Management. Pearson Education Limited.

WALKER, J. S., CHECK, H. F., JR., RANDALL, K. L. (2011): Does the Internal Rate of Return Calculation Require a Reinvestment Rate Assumption? – There Is Still No Consensus, West Chester University: Pennsylvania Economic Association Proceedings Annual Conference, June 3–5, 2010. pp. 118-130.




How to Cite

Illés, M. (2016). The Real Reinvestment Rate Assumption as a Hidden Pitfall. Theory, Methodology, Practice - Review of Business and Management, 12(01), 47–60.

Most read articles by the same author(s)