FM11 18 - use them as a substitute for outside capital...

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c. NPV (Millions of Dollars) Crossover Rate = 11.7% IRR A = 15.03% IRR B = 22.26% A B Cost of Capital (%) 125 IRR = 11.7% 10 100 75 15 50 20 25 25 -25 30 -50 5 d. The NPV method implicitly assumes that the opportunity exists to reinvest the cash flows generated by a project at the cost of capital, while use of the IRR method implies the opportunity to reinvest at the IRR. If the firm's cost of capital is constant at 10 percent, all projects with an NPV > 0 will be accepted by the firm. As cash flows come in from these projects, the firm will either pay them out to investors, or
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Unformatted text preview: use them as a substitute for outside capital which costs 10 percent. Thus, since these cash flows are expected to save the firm 10 percent, this is their opportunity cost reinvestment rate. The IRR method assumes reinvestment at the internal rate of return itself, which is an incorrect assumption, given a constant expected future cost of capital, and ready access to capital markets. Answers and Solutions: 11 - 18...
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