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The Term Structure of Capital Values:An accounting-based framework for measuring economic profitability

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  • Carlo Alberto Magni
  • Ken V. Peasnell

Abstract

This paper shows how the outputs of the accounting measurement process can be translated into terms that can be used in economic decisions. We introduce the notion of Term Structure of Capital Values (TSCV), uniquely associated to a Term Structure of Interest Rates (TSIR). We show that the state of temporary disequilibrium created by an asset (project, firm, etc.) introduced in a market can be described in terms of a pair of internal TSCV and TSIR. Any internal TSCV determines a specific depreciation schedule for the asset and the corresponding TSIR determines an economic rate of return obtained as a capital-weighted average of the Return On Assets collected in the TSIR. The difference between this economic rate of return and the overall equilibrium rate (itself an average of the equilibrium forward rates) correctly captures value creation. The determination of a specific (internal) TSCV depends on the way the market sweeps away arbitrage opportunities and restores the equilibrium. As each possible accounting system can be viewed as being associated with a corresponding disequilibrium-to-equilibrium process and therefore with a corresponding economic rate of return, the paper shows that the determination of an economic rate of return is both a matter of accounting (in terms of a specific internal TSCV) and a matter of finance (in terms of a specific disequilibrium-to-equilibrium process). This evidently calls for a theory of capital valuation capable of associating the proper TSCV with each asset so that the intrinsic underdetermination of the economic rate of return can be solved.

Suggested Citation

  • 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".
    • Handle: RePEc:mod:depeco:0060
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    References listed on IDEAS

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    1. Carlo Alberto Magni, 2009. "Accounting and economic measures:An integrated theory of capital budgeting," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0019, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
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    6. Carlo Alberto Magni, 2010. "Average internal rate of return and investment decisions: A new perspective," PROYECCIONES FINANCIERAS Y VALORACION 006653, MASTER CONSULTORES.
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    23. 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.
    24. Carlo Alberto Magni, 2010. "Average internal rate of return and investment decisions: A new perspective," Proyecciones Financieras y Valoración 6653, Master Consultores.
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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.

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    More about this item

    Keywords

    Average ROA; value creation; disequilibrium; term structure;
    All these keywords.

    JEL classification:

    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • 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

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