reinvest

(verb)

To invest cash again, instead of holding it as cash.

Examples of reinvest in the following topics:

  • Reinvestment Risk

    • Reinvestment risk is one of the main genres of financial risk.
    • Reinvestment risk is more likely when interest rates are declining.
    • Pension funds are also subject to reinvestment risk.
    • Two factors that have a bearing on the degree of reinvestment risk are:
    • Interest rate on the bond - The higher the interest rate, the bigger the coupon payments that have to be reinvested, and, consequently, the reinvestment risk.

  • Dividend Reinvestments

    • Dividend reinvestment plans (DRIPs) automatically reinvest cash dividends in the stock.
    • This is called a dividend reinvestment program or dividend reinvestment plan (DRIP).
    • The purpose of the DRIP is to allow the shareholder to immediately reinvest his or her dividends in the company.
    • Participating in a DRIP, however, does not mean that the reinvestment of the dividends is free for the shareholder.
    • Thus, participating in a DRIP helps shareholders avoid some or all of the fees they would occur if they reinvested the dividends themselves.

  • Reinvestment Assumptions

    • NPV and PI assume reinvestment at the discount rate, while IRR assumes reinvestment at the internal rate of return.
    • Related to this concept is to use the firm's reinvestment rate.
    • Reinvestment rate can be defined as the rate of return for the firm's investments on average.
    • IRR assumes reinvestment of interim cash flows in projects with equal rates of return (the reinvestment can be the same project or a different project).
    • Accordingly, MIRR is used, which has an assumed reinvestment rate, usually equal to the project's cost of capital.

  • Comparing Price Risk and Reinvestment Risk

    • Price risk is positively correlated to changes in interest rates, while reinvestment risk is inversely correlated.
    • So there is little reinvestment risk.
    • There is, accordingly, more reinvestment risk.
    • Reinvestment risk and interest rates are inversely correlated.
    • In summary, price risk and reinvestment risk are two main financial risks resulting from changes in interest rates.

  • Modified IRR

    • Firstly, IRR assumes that interim positive cash flows are reinvested at the same rate of return as that of the project that generated them.
    • This is usually an unrealistic scenario and a more likely situation is that the funds will be reinvested at a rate closer to the firm's cost of capital.
    • Generally, for comparing projects more fairly, the weighted average cost of capital should be used for reinvesting the interim cash flows.
    • To calculate the MIRR, we will assume a finance rate of 10% and a reinvestment rate of 12%.
    • Second, we calculate the future value of the positive cash flows (reinvested at the reinvestment rate): FV (positive cash flows, reinvestment rate) = 5000*(1+12%) +2000 = 7600.

  • Disadvantages of the IRR Method

    • In addition, IRR assumes reinvestment of interim cash flows in projects with equal rates of return (the reinvestment can be the same project or a different project).
    • Therefore, IRR overstates the annual equivalent rate of return for a project whose interim cash flows are reinvested at a rate lower than the calculated IRR.
    • When the calculated IRR is higher than the true reinvestment rate for interim cash flows, the measure will overestimate–sometimes very significantly–the annual equivalent return from the project.

  • ROE and Potential Limitations

    • Return on equity measures the rate of return on the ownership interest of a business and is irrelevant if earnings are not reinvested or distributed.
    • The true benefit of a high return on equity comes from a company's earnings being reinvested into the business or distributed as a dividend.
    • In fact, return on equity is presumably irrelevant if earnings are not reinvested or distributed.

  • Multiple IRRs

    • When a project has multiple IRRs, it may be more convenient to compute the IRR of the project with the benefits reinvested.
    • Accordingly, Modified Internal Rate of Return (MIRR) is used, which has an assumed reinvestment rate, usually equal to the project's cost of capital.

  • Setting the Target Payout Ratio

    • This is appealing to some investors because a lower dividend implies that more earnings are being reinvested in the company, which should cause the stock price to rise.
    • If a company is trying to grow very fast, it may prefer to reinvest its income in expanding operations.

  • Relationship Between Dividend Payments and the Growth Rate

    • These companies also provide limited growth opportunities, since earnings are not reinvested for the purpose of growth.
    • High growth firms in early life generally have low or zero payout ratios in order to reinvest as much of their earnings as possible.