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This article explores the relationship between internal rates of return and common rules of thumb used in capital investment analysis. The authors reexamine questions that were originally posed by economist Myron Gordon while researching the relationship between payback periods, accounting rates of return and the internal rate of return. The authors attempt to achieve generality by viewing these rules of thumb as explicit functions of two variables: the investment proposals' economic lives and their internal rates of return.

An essential phase of a rational capital budgeting process concerns appraising the profitability potentials of recognized opportunities for capital investment. Typically, management must decide upon an effective rationing of capital among the numerous capital proposals recommended to it for adoption. Profitability considerations are manifestly important in such decisions. While the notion of rate of return on investment is commonplace, the term is widely employed to describe a variety of historical and projected mathematical relationships between earnings and investment. In this paper, rate of return refers to that rate of interest which equates through time a project's anticipated cash flows with the initial capital outlay required to adopt rate of return determination explicitly considers all three determinants of a proposal's financial worth and ignores external considerations such as the cost of the capital required to adopt the proposal. Via the discounting procedure, the time value of money is taken into account. A proposal's expected profitability is ex- pressed in a single figure representing the average annual rate of compound interest at which the project's initial investment is expected to be recovered through cash flow generation.

This paper is intended to contribute to the theory of capital budgeting by showing, conclusively, that although the cost of capital (as generally defined) is the correct cut-off point for one investment decision, it is not correct when more than one is being considered. When several investments are simultaneously evaluated, the required rate of return should be higher than the cost of capital. The authors propose for the multi-investment case, instead of using the cost of capital as a hurdle rate, the following decision-rule: Rank projects according to their rate of return, then consider each sequentially and accept the project if its contribution to the percentage increase in profits (taking into consideration all previously accepted projects) exceeds the percentage increase in equity capital required for that project. [ABSTRACT FROM AUTHOR]

The article examines the deferral method using a criterion of earnings and rate-of-return accuracy. The author states that the deferred method of accounting for the problem of accelerated tax depreciation has come under considerable attack because it results in a deferral account which grows in amount with the growth in a firm's rate of spending on depreciable assets. He explains that when one puts the controversy between the deferred method and the nondeferral or flow through method in a new perspective he finds that the deferred method and the accelerated method has considerable merit as a crude way of accounting for assets with declining per-period benefit flows.

The article focuses on a report related to the role of economic and financial research in addressing the practical problems of capital management. The author believes there is a detrimental gap between innovative management techniques and their adoption by companies. He outlines three problems of capital management: measuring worth of investment proposals, devising standards for evaluating proposals, projecting the firm's need for capital funds. He claims that good estimates of investment worth are vital to efficient capital management.

The article presents an exploration into the formation of annualization and overlapping biases in security rate of return statistical models through the underlying bias within the expected geometric mean return concerning the estimation of the population mean. Additional relationships between the geometric mean and the internal rate of return are also outlined.

The article proposes a system of measuring net capital investment (NCI), earnings associated with NCI, and rate-of-return on NCI. This study, then, presumes it worthwhile to develop a system of measuring (NCI, E, ROR) in which the measure of NCI reflects its current cash equivalent. One way to arrive at the current cash equivalent of NCI is to measure or estimate the current exit value of each of the entity's owned resources and senior claims, then apply the balance-sheet identity to the resulting numbers.

This article presents an examination of the contributing factors of financial myopia. The under-utilization of financial resources created opportunities for conglomerate takeovers and an increase in competition. Myopia can exist whenever the corporation fails to invest strategically. Included is the importance of deciding on a target rate of per-share earnings growth. Offered are strategies for how corporations should invest. Additional topics include return on assets, return on equity, and the rate of return.

This paper derives decision rules for corporate capital budgeting when cash flows resulting from the acceptance of projects are risky. The decision rules are in terms of a project's discounted value and rate of return, the two familiar measures of investment profitability under certainty. The analysis of capital projects assumes throughout that stock values are determined in perfect capital markets and also ignores complications which arise due to taxation of corporations and individuals. The results are therefore of theoretical rather than direct practical relevance. [ABSTRACT FROM AUTHOR]

The accounting rate of return (ARR) has traditionally been used as a surrogate for the economic rate of return (IRR) in evaluating the effectiveness of managements' capital investment decisions. Over the years, some question has been raised as to the validity of using the ARR as an approximation of the IRR. Several papers have recently come to grips with this question with varying degrees of success. This paper is intended to expose the conceptual differences between these rates of return, with the goal of clearly pointing out just how useful the ARR can be to management. [ABSTRACT FROM AUTHOR]

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.

The article says that there is no empirically satisfactory solution to the problem of changing capital costs since with any regulatory lag whatsoever earned accounting rates of return above or below the new required rates of return are impounded into the book value rate base. In particular this is the case during periods of increased inflation rates such as in mid-1960s. In those enlightened regulatory jurisdictions in which it is admitted that shareholders' opportunity cost defines allowable rate of return on equity, an interesting division of investigative labor has developed. Economist testimony is solicited as the rate of return on book equity, which the firm should be permitted to earn, while determination of book equity, the allowed rate base, is kept in the province of accounting. The final result is expressed in dollar flow units. The application of cost of equity capital to a book value base tends to drive share price toward book value. Thus, the article says that book value rate base should be used together with conscious use of regulatory lag to realize the rate of return on book equity benefits and costs of non-normal operating efficiency.

The article discusses the profitability of a firm's purchase of its own common stock. Acquisition-minded firms find that companies can frequently be bought more easily on an exchange of stock basis than for cash. The acquiring firm can issue new shares to effect the merger but sometimes it is expedient to buy outstanding stock and use it for this purpose. Another reason companies purchase their own shares is simply as an investment. The true growth company has attractive internal investment opportunities. This means it can invest its available funds in projects that promise a relatively high internal rate of return.

The article comments on the work of M. H. Miller and F. Modigliani, who created a controversy with their ideas on capital costs. While the author concedes that this research was "internally consistent" he also believes that it was linked with traditional theory and aims to show the similarities between this research and that done by A. Barges. A hypothetical is presented in which a merchant in the U.S. considers whether or not to export and import goods from China. The businessperson is aware of the variables involved and makes his final decision on whether or not he believes that the ship will return with its cargo and on expected returns. An additional factor is how the expected return would be affected if the businessperson borrowed the money for the venture.

This paper shows the development of a method for estimating the required rate of return on equity capital for public utilities tinder conditions of growth. The distinguishing feature of the method is the calculation of the required rate of return by making the proper adjustments (for flotation costs and the appropriate market-to-book ratio) to the market-determined investor capitalization rate. If the investor capitalization rate is not adjusted upward but used as the allowed rate of return, the market price of the security will tend toward the book value.8 This fact has long plagued the advocates of the discounted-cash-flow method and caused them either to make an arbitrary upward adjustment to get the allowed rate of return or to make no adjustment and simply recommend an unreasonably low value for the rate of return. The inclusion of a sufficiently high market-to-book ratio to protect against adverse changes in the investor capitalization rate adds the missing link to the discounted-cash-flow method.9 We would hasten to state that the miss- ing link which we have added is theoretical in nature. Our method, on the other hand, is by all means pragmatic. The model presented in this paper does not pretend to eliminate the need for the reconciling role of the American system of regulation. Reasonable men will still differ. But since the assumptions and calculations are laid bare for all to see when a mathematical model is used, it is possible to assess the effects of different assumptions about parameters. This is the role of sensitivity analysis. It can only be of benefit to the regulatory process. [ABSTRACT FROM AUTHOR]