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Aggregate Return on Investment and Investment Decisions: A Cash-Flow Perspective

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  • Carlo Magni

Abstract

The recent notion of average internal rate of return (AIRR; Magni 2010a, The Engineering Economist, 55(2), 150–180) completely solves the long-standing problem of the internal rate of return (IRR). Though the AIRR is a return measure, this article presents a cash-flow measure, namely, the ratio of net cash flow (i.e., cash inflows minus cash outflows) to capital invested, which we call aggregate return on investment (AROI). It is a purely internal measure because, unlike the AIRR, it does not depend on the market rate and is a return measure, because it is a mean of one-period return rates, weighed by the outstanding capitals. The AROI is reliable in both accept/reject decisions and project ranking, in association with an appropriate, economically significant hurdle rate: the comprehensive cost of capital (CCOC), which takes into account not only the interest foregone on the capital actually employed but also the interest foregone on the capital that is given up by the investor. This perspective enables one to decompose the project net present value (NPV) into an excess-rate share and an excess-capital share. The traditional IRR is just a particular case of both AIRR and AROI, but the latter approach has the advantage that the IRR's nature (rate of return versus rate of cost) does not depend on the market rate and is unambiguously determined by the capital invested.

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  • Carlo Magni, 2011. "Aggregate Return on Investment and Investment Decisions: A Cash-Flow Perspective," The Engineering Economist, Taylor & Francis Journals, vol. 56(2), pages 140-169.
    • Handle: RePEc:taf:uteexx:v:56:y:2011:i:2:p:140-169
    DOI: 10.1080/0013791X.2011.573617
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    Citations

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    Cited by:

    1. Magni, Carlo Alberto, 2016. "Capital depreciation and the underdetermination of rate of return: A unifying perspective," Journal of Mathematical Economics, Elsevier, vol. 67(C), pages 54-79.
    2. Dean Altshuler & Carlo Alberto Magni, 2015. "Introducing Aggregate Return on Investment as a Solution to the Contradiction Between Some PME Metrics and IRR," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 15209, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    3. Magni, Carlo Alberto & Marchioni, Andrea, 2019. "The accounting-and-finance of a solar photovoltaic plant: Economic efficiency of a replacement project," MPRA Paper 95263, University Library of Munich, Germany.
    4. Magni, Carlo Alberto & Marchioni, Andrea, 2018. "Project appraisal and the Intrinsic Rate of Return," MPRA Paper 95262, University Library of Munich, Germany.
    5. Biase di Giuseppe & Guglielmo D'Amico & Jacques Janssen & Raimondo Manca, 2014. "A Duration Dependent Rating Migration Model: Real Data Application and Cost of Capital Estimation," Czech Journal of Economics and Finance (Finance a uver), Charles University Prague, Faculty of Social Sciences, vol. 64(3), pages 233-245, June.
    6. Bingyou Chen & Yu Luo & Jieni Li & Yujian Li & Ying Liu & Fan Yang & Junge Bo & Yanan Qiao, 2023. "Blockchain-based Decentralized Co-governance: Innovations and Solutions for Sustainable Crowdfunding," Papers 2306.00869, arXiv.org, revised Jun 2023.
    7. Carlo Alberto Magni & Ken V. Peasnell, 2015. "The Term Structure of Capital Values:An accounting-based framework for measuring economic profitability," Department of Economics 0060, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
    8. Alexandr V. Zhevnyak, . "Reference," NEW CONCEPT OF RETURN ON BORROWED AND INVESTMENT PROJECTS,, Socionet.

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