Critical review of the reinvestment issue in capital investment analysis

When comparing investment alternatives, an analyst may choose from a large number of economic measures. Recent and past studies indicate that the methods of evaluation most commonly used in industry are the payback method, Net Present Value, and Internal Rate of Return. Net Present Value (NPV) and Internal Rate of Return (IRR) are the discounted cash flow (DCF) methods extensively used in economic project analysis. Both are popular in industry and yet both have typically neglected problems. The NPV economic measure uses a minimum attractive rate of return (MARR) that is difficult to define. The IRR does not use a MARR, but controversy surrounds it nevertheless. The controversy regards how the IRR treats the reinvestment of a project's intermediate net cash flows. In addition, for a certain type of cash flow (non-normal) the IRR is difficult to determine and interpret. This article focuses on the central argument against the use of the NPV and IRR as economic measures because of implicit and explicit reinvestment assumptions. The arguments of various authors highlight the different perspectives on the reinvestment issue. This paper highlights issues involved with reinvestment, implications of reinvestment philosophies, and emphasizes the interactions of these many viewpoints.