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The treatment of the reinvestment rate assumption in the literature is sufficiently ambiguous that many. conclude that reinvestment is included in the mechanics of calculating internal rate of return and net present value while others assume that reinvestment is only an implicit assumption necessary when two or more alternatives are compared [7). B ecause of this confusion, many students experience difficulty in grasping the basic concepts of capital analysis. The purpose of this paper is to help clear up this confusion by answering the question: Is a reinvestment rate assumed in the mechanics of calculating the internal rate of return? The Problem To highlight the issue, consider the following investment opportunity in which an initial outlay of $2,880 is made at time t = 0, and cash inflows of $2,000 occur at the end of each of the next two years.

Economic theory indicates that higher m u m s are required from investments that have higher risk. ' h o major reasons for offering trade discounts arc to stimulate sales and to speed up cash receipts. Both sales incTeases and the earlier receipt of cash impact the risk/return characteristics of a firm. This study uscs a Markov chain model to demonstiate how alternative trade credit policies impact the risk and required returns of a fum. The amount of risk and return per credit sale is calculated, and the coefficient of variation is used as a risk/rrturn measure per credit sale. The study concludes that trade discounts can have a favorabk impact on the risk/return characteristics of a firm, even in the absence of i n d sales volume Other discount decision factors which arc either directly or indirectly determined in this paper include: (1) the average number of periods for which an account is outstanding, (2) the probability of collection and baddebt losses over the average account period, (3) the average speed of payment, and (4) the average amount of cash tied up in accounts receivable.Subject Amas: Cwpomtc Finance and Markov Ptocrsscs.

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