Abstract
THE CHOICE OF NET present value (NPV) or intemal rate of return (IRR) for selecting among identical cost, mutually exclusive investment proposals has received wide attention in the financial literature. The subject received extensive treatment more than twenty years ago in a number of papers pertaining to capital budgeting.' More recently, Dudley [3] has shown that while neither the NPV nor IRR criteria makes any assumption about the reinvestment of cash flows the selection of an optimal criterion must be accompanied by explicit reinvestment rate assumptions if the two criteria yield conflicting results. Dudley demonstrates that if the reinvestment rate of return is greater than Fisher's [4] rate of return over cost the IRR method will provide optimal decisions while if it is less than Fisher's rate the NPV method will prove optimal. The problem, then, lies in determining the appropriate reinvestment rate. Dudley (among others)2 suggests that:
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