On a purely theoretical basis, NPV is a better approach to capital budgeting than IRR because NPV implicitly assumes that any intermediate cash inflows generated by an investment are reinvested at the firm's cost of capital.

Question

Quizplus · Accepted Answer

The statement is true. NPV takes into account the time value of money and assumes that any cash inflows generated by an investment can be reinvested at the firm's cost of capital. On the other hand, IRR assumes that any cash inflows are reinvested at the IRR, which may not be the appropriate cost of capital for the firm. This can lead to misleading investment decisions. Therefore, from a theoretical perspective, NPV is considered a better approach to capital budgeting than IRR.

On a Purely Theoretical Basis, NPV Is a Better Approach