ARR vs. IRR: A REVIEW AND AN ANALYSIS

Luckett, Peter F.

doi:10.1111/j.1468-5957.1984.tb00070.x

Cited by 24 publications

(17 citation statements)

References 15 publications

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“…This interesting result is in sharp contrast with the accounting literature on economic rate of return, according to which accounting rates of return do not provide any information about a project's or firm's economic profitability (e.g. Harcourt 1965, Solomon 1966, Livingstone and Salamon 1970, Gordon 1974, Kay 1976, Fisher and McGowan 1983, Luckett 1984, Salamon 1985, Kay and Mayer 1986, Gordon and Stark 1989, Whittington 1988, Feenstra and Wang 2000, Stark 2004. See also Magni 2009a, 2011c, Magni and Peasnell 2012, 2015.…”

Section: The Average Return On Asset (Aroa)contrasting

confidence: 50%

Capital depreciation and the underdetermination of rate of return: A unifying perspective

Magni

2016

Journal of Mathematical Economics

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Abstract. This paper shows that the notion of rate of return is best understood through the lens of the average-internal-rate-of-return (AIRR) model, first introduced in Magni (2010a). It is an NPVconsistent approach based on a coherent definition of rate of return and on the notion of Chisini mean, it is capable of solving the conundrums originated by the rate-of-return notion and represents a unifying theoretical paradigm under which every existing measure of wealth creation can be subsumed. We show that a rate of return is underdetermined by the project's cash-flow stream; in particular, a unique return function (not a unique rate of return) exists for every project which maps depreciation classes into rates of return. The various shapes a rate of return can take on (internal rate of return, average accounting rate of return, modified internal rate of return etc.) derive from the (implicit or explicit) selection of different depreciation patterns. To single out the appropriate rate of return for a project, auxiliary assumptions are needed regarding the project's capital depreciation. This involves value judgment. On one side, this finding opens terrain for a capital valuation theory yet to be developed; on the other side, it triggers the creation of a toolkit of domainspecific and purpose-specific metrics that can be used, jointly or in isolation, for analyzing the economic profitability of a given project. We also show that the AIRR perspective has a high explanatory power that enables connecting seemingly unrelated notions and linking various disciplines such as economics, finance, and accounting. Some guidelines for practitioners are also provided.

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Section: The Average Return On Asset (Aroa)contrasting

confidence: 50%

Capital depreciation and the underdetermination of rate of return: A unifying perspective

Magni

2016

Journal of Mathematical Economics

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“…The structure of the model is in principle similar with those often used in analysing the relationship between the accounting and economic rates of return (for a review see Luckett, 1984). The theoretical model is based on the assumptions of steady state growth and identical investment projects.…”

Section: The Basic Model Of Identical Investment Projectsmentioning

confidence: 99%

Financial Ratios and Different Failure Processes

Laitinen

1991

Business Fin & Account

170

159

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“…We also analytically elaborate the structural differences between these two methods. Furthermore, we can show which theoretical arguments favour the annuity method; however, whether market 2 The discussion of the conditions under which the accounting rate of return (ARR) coincides with the internal rate of return (IRR) (see, among others, Solomon, 1966;Vatter, 1966;Livingstone and Salamon, 1970;Stauffer, 1971;Gordon, 1974;Kay, 1976;Leech, 1976;as well as Peasnell, 1982; for an overview see Luckett, 1984;and Stark, 2004) is somewhat structurally analogous to our research. However, although this discussion arises out of given cash flows and elaborates the conditions of, inter alia, the depreciation method under which ARR equals IRR and focuses on an ex post evaluation of (periodic) performance, our starting point is considering regulatory objectives.…”

Section: Introductionmentioning

confidence: 86%