It’s not a fallacy, so you cannot prove it to be.
Then why was the project not viable at 15% WACC and 20% IRR?
It _ is _ viable at 15% WACC and 20% IRR.
When you get the cash flows from the project, you pay down the principal on the loan.
If you choose not to pay down the principal on the loan, then you have to modify your definition of the “project”, because you’re assuming that the cash flow is still invested.
Yes but at 15% WACC my total principle with interest turned out to be $152 and my project’s cash flows turned out to be $150 at 20% IRR. So I did not make enough to pay back the loan.
I’m just trying to piece the puzzle in a logical manner
What did you do with the cash flow of $40?
I followed the steps you stated in your original post.
The money extracted was put in my pocket and the remaining amount was compounded, so the simulation was as you stated:
Year 0: Deposit $100 I borrowed at 15%
Year 1: $100 became $120, and then I extracted $40. Therefore there’s a remaining $80 in the bank that will be compounded at 20%, and the $40 in my pocket will not be compounded.
Year 2: $80 became $96 and from the $96 I extracted $30. Therefore there’s $66 in the bank that will be compounded at 20%, and there’s $30 in my pocket that won’t be compounded.
Year 3: The $66 became $80 and then I cashed out the $80 and closed the account.
Are you implying that the money I put in my pocket should have been reinvested at the IRR? So the $40 should have been compounded 2 more years at 20%?
40(1+20%)(1+20%) => 57.6
30(1+20%) => 36
80 (no compounding) => 80
57.6 + 36 + 80 => 173.6
now this makes sense, thank you Magician!
IRR assumes returns are reinvested at the IRR. So it doesn’t work if you pocket it early. So to get the expected result you either need to reinvest at irr and then check, or if you don’t have other possible projects with such return, you need to repay principal and then check (even though that would be equivalent to investing @10%).
Thank you as well Nenorr for the further elaboration (:
You’re quite welcome.
You can reinvest it at the IRR (which is usually unrealistic), or you can pay down the principal on your loan.
Sticking it under the mattress (or in your pocket) makes no sense.
Never mind Solved (: