The Arithmetic of Capital-Budgeting Decisions

Solomon, Ezra

doi:10.1086/294102

Cited by 99 publications

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“…By analyzing the Modified Internal Rate of Return -MIRR, Solomon (1956) proposed an introduction to different rates, as the financial project net cash flows were positive or negative. Gonçalves et al (2009) stated that the MIRR is calculated bringing all investment flows to the initial moment by the investment rate and taking the positive flows to the last moment by the reinvestment rate, and calculating the rate that makes the two flows equivalent, i.e., the return internal rate.…”

Section: Resultsmentioning

confidence: 99%

Citriculture Economic and Financial Evaluation Under Conditions of Uncertainty

Simões¹,

Cabral²,

Oliveira³

2015

Rev. Bras. Frutic.

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-The citriculture consists in several environmental risks, as weather changes and pests, and also consists in considerable financial risk, mainly due to the period of return on the initial investment. This study was motivated by the need to assess the risks of a business activity such as citriculture. Our objective was to build a stochastic simulation model to achieve the economic and financial analysis of an orange producer in the Midwest region of the state of Sao Paulo, under conditions of uncertainty. The parameters used were the Net Present Value (NPV), the Modified Internal Rate of Return (MIRR), and the Discounted Payback. To evaluate the risk conditions we built a probabilistic model of pseudorandom numbers generated with Monte Carlo method. The results showed that the activity analyzed provides a risk of 42.8% to reach a NPV negative; however, the yield assessed by MIRR was 7.7%, higher than the yield from the reapplication of the positive cash flows. The financial investment pays itself after the fourteenth year of activity.

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Section: Resultsmentioning

confidence: 99%

Citriculture Economic and Financial Evaluation Under Conditions of Uncertainty

Simões¹,

Cabral²,

Oliveira³

2015

Rev. Bras. Frutic.

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“…Earlier work by Solomon [44] had, however, laid the foundation for Baldwin's 'modifi cation' when Solomon set out to devise a way to solve the problem of multiple internal rate of returnsa problem prone to the standard IRR when the cashfl ows from a project have more than one sign change: which is well recognised in the US from what is known as the Descartes' rule [29]. Such projects are said to be 'non-conventional', while, according to Beaves [4], a 'conventional' project is one where the sequence of cashfl ows has only a single sign change from negative to positive.…”

Section: The Modifi Ed Internal Rate Of Return (Mirr)mentioning

confidence: 97%

An Exploratory study of a comparison between the UK and Czech Republic of the financial models used in the appraisal of ICT and non-ICT capital projects

Hynek¹,

Janeček²,

Lefley³

2015

E+M

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Ekonomika a management widely used in industry, although there is little support for it among the academicians '; and Fisher and Nof [11, pp. 138] argue that the PB is a 'quick-and-dirty rule'. The two most serious disadvantages of the PB model of fi nancial appraisal are (i) it does not take any regard of returns after the payback period and, (ii) it ignores the timing of the returns. The Discounted Payback Model (DPB)In order to overcome the timing of the returns issue of the conventional PB model, a discounted PB model was developed Rappaport [38]. In effect, the DPB is, but, a truncated version of the NPV -looking only at the discounted cashfl ows up to the payback period, and for this reason, it is not a measure of profi tability but simply, like the standard PB model, a measure of liquidity [31], [25]. However, it does take into account a company's cost of capital. The Accounting Rate of Return (ARR)The ARR model attempts to equate the fi nancial data of a capital project with the accrual concept of conventional accounting. It is an attempt to measure the profi t and the capital cost on the same basis as that adopted in preparing the fi nancial accounts of the organisation. The ARR expresses the average return on the investment as a percentage of that investment. The fi gure for investment may be either the initial capital cost of the project (initial capital model, or return on original investment) or, based on the assumption that the cost of the project will reduce to zero or a predetermined residual/ scrap value over the life of the project by way of depreciation, one half of the capital cost (average capital model, or return on average investment). The ARR does not take fully into account the fact that profi ts may vary year by year and, therefore, show an uneven pattern; it ignores the time value of the fl ow of funds, and is not suitable for comparing projects with different life spans. Kee and Bublitz [22] argue that an attraction of the ARR is its simplicity and articulation with accrual accounting measures, by which managers are frequently evaluated. Kelly and Tippett [23] argue that since the ARR is based on book values it is easy to compute and readily understandable by its users. Some academics report that the use of the ARR is in decline [27], while others show that it is a popular model in appraising IT projects [2]. The Net Present Value (NPV)The literature repeatedly states that the NPV is the 'correct' investment appraisal model when looking to aim at maximising shareholder value, see for example Samuels et. al. [41] and Brealey & Myers [6]. The NPV of a project is the sum of all the net discounted cashfl ows during the life of the project less the present value of the capital cost of the project. A positive NPV indicates that if the project is accepted then the organisation's wealth will increase by this NPV. If the NPV is negative then the result will be a reduction in an organisation's net worth, while a zero NPV will result in no change. The Profi tability Index (PI)Some academics s...

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“…Application appropriateness of the two methods is sharply debated from the first half of the last century. Many writings already were born in the 1950s (see Alchian, 1955;Solomon, 1956;Bierman and Smidt, 1957). Since then the discussion is running.…”

Section: Literature Reviewmentioning

confidence: 99%

Problematic methodological questions of investment project evaluation

Illés¹

2017

Management and Organization: Concepts, Tools and Applications

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SummaryThere are some scientific questions related to the NPV and IRR which have not been worked up. From these issues, this paper discusses the economic content of the two categories and the questions of usability for project evaluation and ranking. The main research methods are methodological analysis, model editing and examination of the mathematical formulas. The paper proves that the NPV is the discounted amount of the surplus profit generated above the profit requirement, and points out, that content band of the real reinvestment rate assumption is fundamentally different from everything that can be found about this in the literature. Because of the NPVs are not comparable, the paper systematically eliminates the distortion effects. Thus, the NPV transforms into a special kind of rate, namely, the difference between the factual rate and the required rate of return. This NPV rate (with equal required rates of return) gives the same ranking list as the IRR. The aggregate capital needs is a new conception and gives a new viewpoint to analysis of investment projects evaluation. The paper defines the special content of aggregate capital needs and compiles an index number for it.

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The Arithmetic of Capital-Budgeting Decisions

Cited by 99 publications

References 0 publications

Citriculture Economic and Financial Evaluation Under Conditions of Uncertainty

Citriculture Economic and Financial Evaluation Under Conditions of Uncertainty

An Exploratory study of a comparison between the UK and Czech Republic of the financial models used in the appraisal of ICT and non-ICT capital projects

Problematic methodological questions of investment project evaluation

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