Search

The article examines the uniqueness of the internal rate of return. In the September 1969 issue of the "Economic Journal," Professors J.K. Arrow and D. Levhari demonstrated in their article "Uniqueness of the Internal Rate of Return with Variable Life Investment" that for any project whose life can be costlessly truncated to maximize its present value (PV) at each discount rate there will be only one rate at which this maximized present value is zero, i.e., the internal rate of return is unique. More generally they prove that the maximized PV is a monotonic decreasing function of the discount rate. The authors result show that, whatever the previous pattern of the rates a change in expectations which causes them all to be revised in the same "direction " will alter the present values of all costlessly terminable projects including the residues of extant investment in a common direction.

This article presents the author's reply to the comments on his paper "Monopolies Commission and Rate of Return on Capital." The author says that the main thrust of the criticism is dependent upon a restatement of his own hypothesis which is so distorted as to invalidate the exercise almost in its entirety. The comment rightly centered attention upon the most significant section of the paper, namely that entitled "Does the Choice of Guidepost Make a Difference?," in which the author sets about testing the hypothesis at issue in this discussion. The paper was concerned with the use of rate of return on capital as a regulatory mechanism by the British Monopolies Commission in its investigation of positions of single-firm market power as defined by the British antitrust laws. The hypothesis attributed to the author in the criticism bears no relationship whatsoever to the null hypothesis set out in the paper. The commentator favors a more detailed cost-benefit analysis in antitrust investigations than that currently used by the Monopolies Commission. In this analysis, rate of return on capital criteria would play an important role. No doubt the results of the author's investigation, casting doubt on the general unambiguity of the criteria, were somewhat unpalatable. He has argued elsewhere, however, against the cost-benefit approach to antitrust on more general grounds.

ECONOMISTS are acquainted with the objections to and limitations of using internal rates of return as a selection criterion among investment projects. In a discussion of the uniqueness of the internal rate of return, a few economist (Soper [3], Karmel[1], McManus[2] and others) have proposed and proved the theorem that if it is possible and feasible to truncate investment projects at any moment of time, and if the investor chooses a truncation period which maximises the internal rate of return, then the truncated investment project possesses a unique internal rate of return. However, choosing a truncation period so as to maximise the internal rate of return is not using the proper criterion for the selection of a truncation period. [ABSTRACT FROM AUTHOR]

The implications of the phenomenon of reswitching of techniques for marginal capital theory appear to be the more serious the deeper one goes in uncovering them and bringing them out into the open. The initial result of no general relationship between rate of profit and value of capital goods per man came to contradict the marginal-theory interpretation of the rate of profit as a selector of capital intensity, i.e., as an "index of scarcity" of the "quantity of capital." Further investigation now reveals that another traditional notion, that of "rate of return," is devoid of any autonomous theoretical content. Of course, one can always attribute to the words "rate of return" a meaning. For example, one can choose to use the words "rate of return" as another term for "rate of profit." This has in fact been done in two different ways: by calling "rate of return" that rate of profit at which two techniques are equally profitable, and by following the enterpreneurs' practice of calling "rate of return" that rate of profit which is associated with a particular investment project, when all prices are taken as given. But if one does so, i.e., if one uses the words "rate of return" as a synonym for "rate of profit," one cannot obviously pretend to use the notion of rate of return to explain the rate of profit. The idea which had been basic to marginal capital theory was another and a deeper one. The idea was that, even at the simplest stage of a stationary economic system, there exists something--to be called the "rate of return "--which can be defined autonomously and independently of thc rate of profit; something which is higher or lower according to whether thc existing "quantity of capital" is lower or higher, and as such represents a general technical property of the existing "quantity of capital." Such a thing would justify and explain the rate of profit. It is this idea which has been shown to be an illusion; for, in general, such a thing does not exist. LU... [ABSTRACT FROM AUTHOR]

The article focuses on the concept of continuity and the rate of return. An economist describes the rate of return with the rate of profit at a switch point. With the same wage rate, net profit per man is higher, therefore the cost of capital equalizes the rate of profit. A more schematic treatment of continuity would allow to say that yet small, the difference between two adjacent wage-rates, there is always one method that is eligible to both, with the suitable pair of rates of profit and patterns of prices. A variation in wage rate brings a different set of prices into play. The difference between these two concepts arises from the difference in the arguments in which they occur. The one-commodity economy was devised to allow the neo-classical allegory in which the rate of profit equates to the marginal product of capital.

This study examines empirically the determinants of the rate of return on common stocks for ten cross-sections of 86 common stocks for the years 1958-1967 in a multiple regression analysis. Theoretically, the common stock rate of return under investigation, y, is defined as the ratio of the expected income associated with a particular equity to the market value of that equity. Empirically, this rate is represented by the logarithm of the ratio of a weighted average of past annual share earnings to current market value of the share, r = log y. The empirical rate of return, r, is postulated to be a linear function of two groups of variables: a corrective group and an explanatory one. (1) The corrective variables are employed to attenuate errors involved in the measurement of the empirical representation of expected income in the numerator of the rate of return. (2) The explanatory variables are presumed to represent factors which exert a real influence on the relative desirability of stocks. They are employed to provide an explanation of the rate of return based on preferences and aversions of people in the market to various attributes of common stocks. [ABSTRACT FROM AUTHOR]

The article analyzes the durability vs. construction period aspect of project selection. The author argues that the standard recommendation on the calculation of present-value maximization or internal rate of return in project selection is seldom fulfilled in actual planning situation. A particular situation (suppose alternative projects producing roughly the same commodity are available and projects with longer durability or technical life-time also take a longer period to construct) so as to depict a clear picture on the topic is cited. The problem that can be derived from this particular situation is to ascertain the economic advantages of longer durability of fixed capital assets against disadvantages of longer construction period in the installation of such assets.

The article examines the marginal social time preference rate versus social opportunity cost in investment criteria. In their impressive survey in the journal "Economic Journal" of December 1965, two researchers summarise some recent writings on investment criteria with the statement that no single rate of interest can serve both to compare benefits and costs of different dates and to measure the opportunity costs of private investment displaced by public investment. This is so, the argument runs, because the marginal social rate of time preference is unlikely to coincide with the marginal social rate of return from investment. The implication is that investments cannot be ranked in an order of preference using a rate of interest equal to the opportunity cost of capital. This conclusion does not seem to hold in a fully employed economy in which the estimated risk-adjusted marginal rate of return from investment differs from the estimated social time preference rate. In such a situation there must be presumed to be at any time a number of unexploited investment opportunities offering risk-adjusted rates of return closely similar to the marginal productivity of capital.