Does IRR assume the interim cash flows are reinvested? Various sources say yes and others say no. Investopedia's IRR article says "One of the disadvantages of using IRR is that all cash flows are assumed to be reinvested at the same discount rate". I was also taught this in my Corp Finance class as well.
But this link says otherwise:
"The internal rate of return measures the return on the outstanding "internal" investment amount remaining in an investment for each period it is invested. The outstanding internal investment, as demonstrated above, can increase or decrease over the holding period. It says nothing about what happens to capital taken out of the investment. And contrary to popular belief, the IRR does not always measure the return on your initial investment."
Would you guys say the above link is technically correct? I tried an example in Excel where I invest $100 for 5 years and make a 5% return in year 1, then compound the return by 5% through year 5 where I also receive the principle. Discounting all these cash flows gives a positive NPV and an IRR of 5.5% even though the investment has a compounded return rate of 5%.
Is it accurate to say that IRR does not necessarily represent the annual (or periodic) return on an investment, but as " the percentage rate earned on each dollar invested for each period it is invested."?