- CFA Exams
- CFA Exam: Level I 2021
- Study Session 10. Corporate Finance (1)
- Reading 32. Capital Budgeting
- Subject 3. Investment Decision Criteria

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**CFA Practice Question**

Company A is considering a capital investment project. The appropriate discount rate for the project is WACC = 5%. The project has the following NPV and IRR: NPV = $50,000, IRR = 6.5%.

II. If all cash flows for the project are reinvested to earn actually more than 6.5%, then the project's realized return will exceed its IRR.

III. If all cash flows for the project are reinvested to earn actually less than 6.5%, then the project's realized return will be less than its IRR.

Which of the following statements is (are) true?

I. If all cash flows for the project are reinvested to earn 6.5%, then the project's realized return will equal its IRR.

II. If all cash flows for the project are reinvested to earn actually more than 6.5%, then the project's realized return will exceed its IRR.

III. If all cash flows for the project are reinvested to earn actually less than 6.5%, then the project's realized return will be less than its IRR.

Correct Answer: I, II and III

IRR calculation for a capital investment project assumes that all cash flows can be reinvested to earn exactly the IRR. If the cash flows are invested at a rate lower than the IRR, the realized return will be less than the IRR. If, however, the cash flows are invested at a rate higher than the IRR, the realized return will be greater than the IRR.

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**User Contributed Comments**
5

User |
Comment |
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limpus |
This assumes that there are more than 2 cash flows (one out at t=0 and one in at t=n). In this situation II and III should both read EQUAL rather than exceed and less than respectively. |

surob |
Limpus, per CFA book, it shouldn't be equal as you are suggesting. |

ThanhBUI |
CF reinvestment at IRR is the assumption for calculating IRR in the first place. |

95kalexand |
correct surob .. that's an error on AN part, i believe |

charliedba |
IRR is the rate you calculate BEFORE the project starts. Yes that's the ASSUMED reinvestment rate. Then you have an actual realized rate, which is what happens. You can always compare the ASSUMED and ACTUAL reinvestment rate, and they are unequal in cases II and III. |