Jonathan Langton


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The False Reinvestment Assumption and the Propagation of Incorrect Ideas – Part 3

In the first post on this subject it was seen that the origin of the Reinvestment Assumption is based in confusion and misinterpretation, and that it has been shown to be unnecessary by academics in the peer-reviewed literature.  The second post looked a little more closely at clarifying the confusion that spawned the fallacious concept and a common error employed in its justification.  However the question remains, of how this demonstrably flawed idea maintains its credibility, which clearly it does, among so many academics and professionals in the field.  Hence the most startling discovery of Keef and Roush“On average, over seven-tenths of all texts in [the] sample, independent of their academic discipline, offered the fallacy”, that is, the Reinvestment Assumption.  This finding shows that there is fairly high probability that anyone who has studied the concepts of NPV and IRR will have heard of the Reinvestment Assumption, thus it endures and it is interesting to consider just how this situation is propagated. Continue reading


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The False Reinvestment Assumption and the Propagation of Incorrect Ideas – Part 2

In the previous post the potential origins of the Reinvestment Assumption were examined, as well as its discrediting by academics in the peer-reviewed literature.  Offered here is an explanation of why the discrepancy between NPV and IRR for ranking investments, which leads some to invoke of the Reinvestment Assumption, should be quite evident.  In addition a clear logical flaw in one of the commonly offered mathematical justifications for the fallacy is exposed. Continue reading


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The False Reinvestment Assumption and the Propagation of Incorrect Ideas – Part 1

The Net Present Value and the Internal Rate of Return are two of the most fundamental tools for evaluating investments in Financial Accounting.  When discussing these concepts, one often hears reference to the Reinvestment Assumption, that is, broadly, the assumption that cash-flows generated by an investment are reinvested at the relevant discount rate.   This misconceived assumption is false and unnecessary, yet it continues to be taught extensively and is defended by many finance professionals.  One study suggests that it is contained in over 70% of available texts on the subject.  Where does it come from, and just how does a demonstrably incorrect concept become so entrenched? Continue reading