Original Articles

The re-investment assumption in capital budgeting examined

Published in: Investment Analysts Journal
Volume 2, issue 3, 1973, pages: 29–32
DOI: 10.1080/10293523.1973.11082421
Author(s): M. F. van Breda

Abstract

Capital budgeting is gaining an increasingly prominent place in investment analysis. The many assumptions that it introduces are often overlooked or not fully appreciated. This article sets out to examine a few of them. It begins by demonstrating that both the net present value method and the internal rate of return method (sometimes referred to as the discounted cash flow method) give identical answers for acceptance- rejection decisions on single projects. The apparent conflict between these two methods in comparing mutually exclusive projects is then examined. It is shown that this conflict arises from assumptions regarding the re-investment of funds generated by the project. Analysis by calculation of terminal values is suggested to enable the restrictions imposed by these assumptions to be removed. The article closes with a fairly detailed example of a terminal value calculation, which is free of implicit assumption.

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