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The Internal Rate of Return Approach and the AIRR Paradigm: A Refutation and a Corroboration

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  • Carlo Magni

Abstract

This article shows that the internal rate of return (IRR) approach is unreliable and that the recently introduced average internal rate of return (AIRR) model constitutes the basis for an alternative theoretical paradigm of rate of return. To this end, we divide the paper into two parts: a pars destruens and a pars construens. In the “destructive” part, we present a compendium of 18 flaws associated with the IRR approach. In the “constructive” part, we construct the alternative approach from four (independent) economic intuitions and put the paradigm to the test by showing that it does not suffer from any of the flaws previously investigated. We also show how the IRR, as a rate of return, is absorbed into the new approach.

Suggested Citation

  • Carlo Magni, 2013. "The Internal Rate of Return Approach and the AIRR Paradigm: A Refutation and a Corroboration," The Engineering Economist, Taylor & Francis Journals, vol. 58(2), pages 73-111.
    • Handle: RePEc:taf:uteexx:v:58:y:2013:i:2:p:73-111
    DOI: 10.1080/0013791X.2012.745916
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    Cited by:

    1. Quan Dai & Hongfei Jia & Yao Liu, 2020. "Private vehicle-based crowdshipping for intercity express transportation: Feasibility assessment," International Journal of Distributed Sensor Networks, , vol. 16(2), pages 15501477209, February.
    2. Magni, Carlo Alberto, 2015. "Investment, financing and the role of ROA and WACC in value creation," European Journal of Operational Research, Elsevier, vol. 244(3), pages 855-866.
    3. 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.
    4. Andrea Marchioni & Carlo Alberto Magni & Davide Baschieri, 2020. "Investment and Financing Perspectives for a Solar Photovoltaic Project," MIC 2020: The 20th Management International Conference,, University of Primorska Press.
    5. Carlo Alberto Magni, 2016. "An Average-Based Accounting Approach to Capital Asset Investments: The Case of Project Finance," European Accounting Review, Taylor & Francis Journals, vol. 25(2), pages 275-286, June.
    6. Weber, Thomas A., 2014. "On the (non-)equivalence of IRR and NPV," Journal of Mathematical Economics, Elsevier, vol. 52(C), pages 25-39.
    7. Andrea Marchiioni & Carlo Alberto Magni, 2016. "Sensitivity analysis and investment decisions: NPV-consistency of rates of return," Department of Economics 0089, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
    8. Maria-Teresa Bosch-Badia & Joan Montllor-Serrats & Maria-Antonia Tarrazon-Rodon, 2020. "The Capital Budgeting of Corporate Social Responsibility," Sustainability, MDPI, vol. 12(9), pages 1-28, April.
    9. Cuthbert, James R. & Magni, Carlo Alberto, 2016. "Measuring the inadequacy of IRR in PFI schemes using profitability index and AIRR," International Journal of Production Economics, Elsevier, vol. 179(C), pages 130-140.
    10. 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".
    11. Ayub, Yousaf & Ren, Jingzheng & He, Chang, 2024. "Unlocking waste potential: A neural network approach to forecasting sustainable acetaldehyde production from ethanol upcycling in biomass waste gasification," Energy, Elsevier, vol. 299(C).
    12. Marchioni, Andrea & Magni, Carlo Alberto, 2018. "Investment decisions and sensitivity analysis: NPV-consistency of rates of return," European Journal of Operational Research, Elsevier, vol. 268(1), pages 361-372.
    13. Magni, Carlo Alberto & Marchioni, Andrea, 2018. "Project appraisal and the Intrinsic Rate of Return," MPRA Paper 95262, University Library of Munich, Germany.
    14. Carlo Alberto Magni, 2015. "Investment, financing and the role of ROA and WACC in value creation," Department of Economics 0050, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
    15. Giuseppe Bonazzi & Mattia Iotti, 2016. "Evaluation of Investment in Renovation to Increase the Quality of Buildings: A Specific Discounted Cash Flow ( DCF ) Approach of Appraisal," Sustainability, MDPI, vol. 8(3), pages 1-17, March.
    16. Ben-Horin, Moshe & Kroll, Yoram, 2017. "A simple intuitive NPV-IRR consistent ranking," The Quarterly Review of Economics and Finance, Elsevier, vol. 66(C), pages 108-114.
    17. Magni, Carlo Alberto & Marchioni, Andrea, 2020. "Average rates of return, working capital, and NPV-consistency in project appraisal: A sensitivity analysis approach," International Journal of Production Economics, Elsevier, vol. 229(C).
    18. Vicente Alcaraz Carrillo De Albornoz & Antonio Lara Galera & Juan Molina Millán, 2018. "Is It Correct to Use the Internal Rate of Return to Evaluate the Sustainability of Investment Decisions in Public Private Partnership Projects?," Sustainability, MDPI, vol. 10(12), pages 1-15, November.
    19. Tao, Jacqueline Yujia & Finenko, Anton, 2016. "Moving beyond LCOE: impact of various financing methods on PV profitability for SIDS," Energy Policy, Elsevier, vol. 98(C), pages 749-758.
    20. Riccardo Testa & Salvatore Tudisca & Giorgio Schifani & Anna Maria Di Trapani & Giuseppina Migliore, 2018. "Tropical Fruits as an Opportunity for Sustainable Development in Rural Areas: The Case of Mango in Small-Sized Sicilian Farms," Sustainability, MDPI, vol. 10(5), pages 1-17, May.
    21. Simona Hašková & Petr Fiala, 2023. "Internal Rate of Return Estimation of Subsidised Projects: Conventional Approach Versus fuzzy Approach," Computational Economics, Springer;Society for Computational Economics, vol. 62(3), pages 1233-1249, October.
    22. 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".
    23. Alexandr V. Zhevnyak, . "Reference," NEW CONCEPT OF RETURN ON BORROWED AND INVESTMENT PROJECTS,, Socionet.
    24. Golnoosh Babaei & Shahrooz Bamdad, 2020. "A neural‐network‐based decision‐making model in the peer‐to‐peer lending market," Intelligent Systems in Accounting, Finance and Management, John Wiley & Sons, Ltd., vol. 27(3), pages 142-150, July.

    More about this item

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G00 - Financial Economics - - General - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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