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Average Internal Rate of Return and Investment Decisions: A New Perspective.
- Source :
-
Engineering Economist . 2010, Vol. 55 Issue 2, p150-180. 31p. 3 Diagrams, 3 Charts. - Publication Year :
- 2010
-
Abstract
- The internal rate of return (IRR) is often used by managers and practitioners for investment decisions. Unfortunately, it has serious flaws: (1) multiple real-valued IRRs may arise; (2) complex-valued IRRs may arise; (3) the IRR is, in general, incompatible with the net present value (NPV) in accept/reject decisions; (4) the IRR ranking is, in general, different from the NPV ranking; (5) the IRR criterion is not applicable with variable costs of capital. The efforts of economists and management scientists in providing a reliable project rate of return have generated over the decades an immense bulk of contributions aiming to solve these shortcomings. This article offers a complete solution to this long-standing unresolved issue by changing the usual perspective: the IRR equation is dismissed and the evaluator is allowed to describe the project as an investment or a borrowing at his discretion. This permits showing that any arithmetic mean of the one-period return rates implicit in a project reliably informs about a project's profitability and correctly ranks competing projects. With such a measure, which we call average internal rate of return, complex-valued numbers disappear and all the above-mentioned problems are wiped out. The economic meaning is compelling: it is the project return rate implicitly determined by the market. The traditional IRR notion may be found as a particular case. [ABSTRACT FROM AUTHOR]
Details
- Language :
- English
- ISSN :
- 0013791X
- Volume :
- 55
- Issue :
- 2
- Database :
- Academic Search Index
- Journal :
- Engineering Economist
- Publication Type :
- Academic Journal
- Accession number :
- 51253852
- Full Text :
- https://doi.org/10.1080/00137911003791856