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Mathematical Analysis of Average Rates of Return and Investment Decisions: The Missing Link

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  • Carlo Alberto Magni

Abstract

This paper expands Teichroew, Robichek and Montalbano's (TRM) (1965a, b) rate-of-return model into a complete and general model of economic profitability for investment decision-making. Specifically, TRM's assumptions are relaxed and a project rate of return is derived, expressing the project's overall economic profitability; direct relations among rates, costs of capital and net present value are supplied. The various value drivers are identified and isolated, and the NPV is decomposed into financing NPV and investment NPV. The approach allows for any pattern of financing rates, investment rates, and costs of capital. Relations with old literature and new literature on rates of return are shown: the link between them is obtained by making use of the mean operator (i.e., an affine combinations of rates) and via the one-to-one correspondence between rates and invested capitals.

Suggested Citation

  • Carlo Alberto Magni, 2014. "Mathematical Analysis of Average Rates of Return and Investment Decisions: The Missing Link," Proyecciones Financieras y Valoración 10994, Master Consultores.
    • Handle: RePEc:col:000463:010994
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    Cited by:

    1. 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.
    2. 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.
    3. 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.

    More about this item

    Keywords

    Capital investment analysis; rate of return; net present value; financing; average;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • D4 - Microeconomics - - Market Structure, Pricing, and Design

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