On Relevant and Irrelevant Internal Rates of Return

Hajdasiński, Miroslaw M.

doi:10.1080/00137918708902973

Cited by 11 publications

(4 citation statements)

References 2 publications

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“…Hence, we have the following These problems are well-known in the economic literature. 5 A huge amount of contributions have been devoted to them and to proposals for mitigating the IRR's awkwardness (e.g., Boulding, 1935, 1936b, Samuelson, 1946Lorie and Savage, 1955;Solomon, 1956;Hirshleifer, 1958;Pitchford and Hagger, 1958;Bailey, 1959;Karmel, 1959;Soper, 1959;Wright, 1959;Kaplan, 1965Kaplan, , 1967Jean, 1968;Arrow and Levhari, 1969;Adler, 1970;Ramsey, 1970;Norstrøm, 1971;Flemming and Wright, 1971;Aucamp and Eckardt, 1976;Bernhard, 1977Bernhard, , 1979Herbst, 1978;Ross, Spatt and Dybvig, 1980;Dorfman, 1981;Gronchi, 1986;Hajdasinski, 1986Hajdasinski, , 2004Promislow and Spring, 1996;Bernhard, 2003;Hazen, 2003Hazen, , 20096 Rocabert, Tarrío, Pérez, 2005;Kierulff, 2008;Simerská, 2008). 4 For example, the project with cash-flow vector ሺ−4,12, −9ሻ has a unique IRR equal to ‫ݎ‬ = 0.5, but the NPV is negative for any other rate.…”

Section: The Three Links and Some Preliminary Resultsmentioning

confidence: 99%

Accounting and Economic Measures: An Integrated Theory of Capital Budgeting

Magni

2009

SSRN Journal

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Accounting measures are traditionally considered not significant from an economic point of view. In particular, accounting rates of return are often regarded economically meaningless or, at the very best, poor surrogates for the IRR, which is held to be "the" economic yield. Likewise, residual income does not enjoy, in general, periodic consistency with the project NPV, so residual income maximization is not equivalent to NPV maximization. This paper shows that the opposition accounting/economic is artificial and, taking a capital budgeting perspective, illustrates the strong (formal and conceptual) connections existing between economic measures and accounting measures. In particular, the average accounting rate of return is the correct economic yield of a project; the traditional IRR is (whenever it exists) only a particular case of it. The average accounting rate generates a decision rule which is logically equivalent to the NPV rule for both accept/reject decisions and project ranking. The paper also shows that maximization of the simple arithmetic mean of residual incomes is equivalent to NPV maximization, owing to its periodic consistency in the sense of Egginton (1995). Such an index may then be used for incentive compensation as well. Moreover, asset pricing may be interpreted in accounting terms as the process whereby the market determines the income impact on the assets' value. As a result, the paper harmonizes the notions of accounting rate of return, internal rate of return, residual income, net present value: they are just different ways of cognizing the same notion. This conciliation stems in a rather natural way from three sources: (i) a fundamental accounting identity, which links income and cash flow in a comprehensive way, (ii) the definition of Chisini mean, (iii) a notion of residual income which takes account of the "real" (comprehensive) cost of capital.

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Section: The Three Links and Some Preliminary Resultsmentioning

confidence: 99%

Accounting and Economic Measures: An Integrated Theory of Capital Budgeting

Magni

2009

SSRN Journal

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“…The economic and managerial literature has thoroughly investigated the IRR shortcomings and a huge amount of contributions in the past eighty years have been devoted to searching for corrective procedures capable of healing its flaws (e.g. Boulding 1935, 1936b, Samuelson 1946Lorie and Savage 1955;Solomon 1956;Hirshleifer 1958;Pitchford and Hagger 1958;Bailey 1959;Karmel 1959;Soper 1959;Wright 1959;Kaplan 1965Kaplan , 1967Jean 1968;Arrow and Levhari 1969;Adler 1970;Ramsey 1970;Norstrøm 1967Norstrøm , 1972Flemming and Wright 1971;Fairley and Jacoby 1975;Aucamp and Eckardt 1976;Bernhard 1967Bernhard , 1977Bernhard , 1979Bernhard , 1980De Faro 1978;Herbst 1978;Ross, Spatt and Dybvig 1980;Dorfman 1981;Cannaday, Colwell and Paley 1986;Gronchi 1986;Hajdasinski 1987Hajdasinski , 2004Promislow and Spring 1996;Tang and Tang 2003;Rocabert, Tarrío and Pérez 2005;Zhang, 2005;Kierulff 2008;Simerská 2008).…”

Section: Introductionmentioning

confidence: 99%

“…Teichroew, Robichek and Montalbano (1965a,b) and Gronchi (1987) circumvent the IRR problems by using a pair of different return rates applied to the project balance depending on its sign (one of which is the market rate itself). The notion of relevant internal rate of return has been studied by Cannaday, Colwell and Paley (1986), Hajdasinski (1987) Hartman and Schafrick (2004). Issues related to the reinvestment assumptions in the IRR criterion and the adoption of the Modified Internal Rate of Return have been analyzed in several contributions, among which Lorie and Savage (1955), Lin (1976), Lohmann (1988), Hajdasinski (2004), Kierulff (2008) (see also the historical perspective of Biondi 2006).…”

Section: Introductionmentioning

confidence: 99%

Average Internal Rate of Return and Investment Decisions: A New Perspective

Magni

2010

The Engineering Economist

131

104

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The internal rate of return (IRR) is often used by managers and practitioners for investment decisions. Unfortunately, it has serious flaws: (i) multiple real-valued IRRs may arise, (ii) complex-valued IRRs may arise, (iii) the IRR is, in general, incompatible with the net present value (NPV) in accept/reject decisions (iv) the IRR ranking is, in general, different from the NPV ranking, (v) the IRR criterion is not applicable with variable costs of capital. The efforts of economists and management scientists in providing a reliable project rate of return have generated over the decades an immense bulk of contributions aiming to solve these shortcomings. This paper offers a complete solution to this long-standing issue by changing the usual perspective: the IRR equation is dismissed and the evaluator is allowed to describe the project as an investment or a borrowing at his discretion. This permits to show that any arithmetic mean of the one-period return rates implicit in a project reliably informs about a project's profitability and correctly ranks competing projects. With such a measure, which we name "Average Internal Rate of Return", complex-valued numbers disappear and all the above mentioned problems are wiped out. The economic meaning is compelling: it is the project return rate implicitly determined by the market. The traditional IRR notion may be found back as a particular case.

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“…This is the case of an investment with an initial cost and all the return at the end of the useful life [14,15].…”

Section: Marr Err Irrmentioning

confidence: 99%

A Rigorous Mathematical Approach to the Economic Rate of Return (ERR) and its Application to Economic Analysis

Asrawi¹,

Noueihed²

2017

Ind Eng Manage

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The economic rate of return (ERR) is a measure of the profitability of a revenue generating investment based on a single external discount rate which is the hurdle rate or the minimum attractive rate of return (MARR).In this paper, we will highlight on the practical and reasonable interpretation of the (ERR) as a reinvestment rate of the present worth of costs. We shall give the usual mathematical definition of the (ERR) and derive an alternative, more useful, and applicable definition in terms of the benefit-cost ratio. We will also investigate the behavior of the (ERR) function in terms of the (MARR) as a variable. A relationship between the (ERR) and the internal rate of return (IRR) will be established. Finally, the applicability of the (ERR) method as an economic analysis method will be demonstrated.

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On Relevant and Irrelevant Internal Rates of Return

Cited by 11 publications

References 2 publications

Accounting and Economic Measures: An Integrated Theory of Capital Budgeting

Accounting and Economic Measures: An Integrated Theory of Capital Budgeting

Average Internal Rate of Return and Investment Decisions: A New Perspective

A Rigorous Mathematical Approach to the Economic Rate of Return (ERR) and its Application to Economic Analysis

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