Methods for Calculating Profitabilities

Abstract

To rank a variety of ventures in the order of their profitability, a yardstick is needed in which both the profit and the time at which this profit is realized are included. This paper describes methods for evaluating two of the more common yardsticks, i.e., the present day value or the total profit for a fixed interest rate and the internal rate of return. No attempt is made to present arguments in favor of either of these criteria. Based on a number of simplifying assumption, tables and graphs have been prepared with the aid of which the profitability of single incomes, constant incomes, and three types of declining incomes can be calculated for a wide range or interest rates. Two examples are given to explain the use of the graphs and tables. Introduction The total profit of a venture is by definition the difference between the total net income and the capital investment. Where, as is usually the case, the investor has a choice of ventures in which he can invest his money, he will need a single yardstick to rank these ventures according to their profitability. It is at once obvious that the total profit cannot always be a sufficient criterion: a smaller profit returned to its investor after a short time may be more desirable than a larger one, for which the investor has to wait a long time. A yardstick by which ventures can be ranked uniquely according to their degree or profitability must therefore incorporate the monetary value of the profits and the time at which they are returned to the investor. Several yardsticks are being used in the oil industry which more or less approach this criterion. In the present paper only two will be considered: the present day value (or deferred value) or the total profit, and the internal rate of return ["yield", "earning power", "rate of return," etc.]

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