The Arithmetic of Capital-budgeting Decisions

Solomon, Ezra

doi:10.1016/b978-0-08-019605-3.50043-2

Cited by 48 publications

(53 citation statements)

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“…The key to understand and resolve the problems of multiple or negative or no IRR is to evaluate the NCF stream carefully to eliminate these problems. Many authors (Solomon, 1956;Lohmann, 1988) reported that the IRR method 4 assumes reinvestment of positive interim cash flows at the same rate (equivalent to IRR). Obviously, interest income on reinvested interim income if included as part of benefit stream, may cause the problem.…”

Section: Methodsmentioning

confidence: 99%

Non‐monotonic NPV Function Leads to Spurious NPVs and Multiple IRR Problems: A New Method that Resolves these Problems

Arjunan¹

2019

J of App Econs and Policy

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The causes and effects of non‐monotonic NPV functions are evaluated and the results presented in this paper. Reinvestment of intermediate income causes non‐monotonic NPV function. Non‐monotonic NPV function not only leads to multiple IRRs but also to spurious NPVs. The capital amortisation (CAS) method used in this analysis transparently reveals if there is any reinvestment. A modified CAS method, discussed in this paper, eliminates the reinvestment and resolves the problems of non‐monotonic NPV function, reinvestment, spurious NPVs and multiple IRR. The current practice of using NPV as the preferred criterion, when there are multiple IRRs, is not appropriate.

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Section: Methodsmentioning

confidence: 99%

Non‐monotonic NPV Function Leads to Spurious NPVs and Multiple IRR Problems: A New Method that Resolves these Problems

Arjunan¹

2019

J of App Econs and Policy

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“…A number of researchers [4,6,11,14,16,17,[23][24][25][26] have attempted to create yield-based substitutes for the IRR method by adjusting the cash flow stream through explicit reinvestment rates. Likewise, critics of these methods have pointed out their shortcomings and inconsistencies.…”

Section: Explicit Reinvestment Rate Methodsmentioning

confidence: 99%

“…Solomon [23] presents an early terminal value method, as previously cited. To solve the ranking problem for two mutually exclusive projects, Solomon suggests compounding the noninitial cash flows at the "cost of capital" to find a terminal value at a time equal to the last period of the longer lived project.…”

Section: Explicit Reinvestment Rate Methodsmentioning

confidence: 99%

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Discounted Cash Flow With Explicit Reinvestment Rates–tutorial and Extension

McDaniel

McCarty

Jessell

1986

The Financial Review

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This article discusses and critiques yield‐based capital budgeting techniques that have arisen over the past 30 years. Some have theoretical inconsistencies, while some work well only for certain kinds of problems. A new method, the marginal return on invested capital, is presented. The method's application is general; it gives accept/reject signals and rankings consistent with the net present value method.

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“…The debate on reinvestment of intermediate income in IRR and NPV estimates, used in capital investment analysis, has continued since the 1950s (Solomon 1956;Renshaw 1957). Dudley (1972) maintained that the discounted cash flow (DCF) methodology by itself does not make any such assumptions.…”

Section: Literature Reviewmentioning

confidence: 99%

Cost‐benefit Analysis and the Controversial Reinvestment Assumption in IRR and NPV Estimates: Some New Evidence Against Reinvestment Assumption

Arjunan

Kannapiran

2017

J of App Econs and Policy

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The reliability of CBA and the capital investment analysis is often questioned because of the controversy surrounding the assumption of reinvestment. The validity of this assumption is evaluated using new approaches and the results are summarised in this paper. These results provide sufficient evidence that there is no reinvestment of intermediate income in the internal rate of return (IRR) or net present value (NPV) estimates. The results are consistent under both normal and non‐normal cash flow projects. Obviously, text books dealing with capital investment analysis should move away from such an assumption. The CBA and the capital investment analysis using the IRR and NPV is, therefore, reliable.

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The Arithmetic of Capital-budgeting Decisions

Cited by 48 publications

References 0 publications

Non‐monotonic NPV Function Leads to Spurious NPVs and Multiple IRR Problems: A New Method that Resolves these Problems

Non‐monotonic NPV Function Leads to Spurious NPVs and Multiple IRR Problems: A New Method that Resolves these Problems

Discounted Cash Flow With Explicit Reinvestment Rates–tutorial and Extension

Cost‐benefit Analysis and the Controversial Reinvestment Assumption in IRR and NPV Estimates: Some New Evidence Against Reinvestment Assumption

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