The two sides of the reinvestment assumption fallacy in IRR and NPV

This methodological article addresses a persistent and consequential fallacy in capital budgeting and financial investments: the belief that Net Present Value (NPV) and Internal Rate of Return (IRR) implicitly assume reinvestment of interim cash flows. Despite decades of scholarly clarification, most notably by Keane (1979), this misconception continues to affect academic discourse and practical decision-making. The paper offers multiple proofs that neither NPV nor IRR requires any reinvestment assumption, and it explains how the fallacy can distort investment evaluations and lead to flawed financial reasoning. The origins of the confusion are traced to early efforts to resolve ranking conflicts between IRR and NPV and to address the problem of multiple IRRs. A central source of this misunderstanding is the misinterpretation of a sufficient condition for IRR-NPV compatibility (which involves reinvestment) as an implicit reinvestment assumption. A key contribution is the distinction between exogenous reinvestment assumptions (artificially imposed post-modeling, after cash flows have been projected) and endogenous reinvestment (used during cash flow modeling to determine distributions to capital providers). This distinction is formalized using Magni's (2020, 2023) accounting-and-finance engineering framework, which explicitly models how payout and retention policies shape the cash flow stream. By integrating reinvestment dynamics directly into the modeling phase, the framework ensures conceptual clarity, removes artificial assumptions, and supports more accurate investment analysis and decision-making.