Decision Making Using Multiple Rates of Return: An Alternative Approach (original) (raw)

The Internal Rate of Return Approach and the AIRR Paradigm: A Refutation and a Corroboration

The Engineering Economist, 2013

This paper shows that the Internal-Rate-of-Return (IRR) approach is unreliable, and that the recently introduced Average-Internal-Rate-of-Return (AIRR) model constitutes the basis for an alternative theoretical paradigm of rate of return. To this end, we divide the paper into two parts: a pars destruens and a pars construens. In the "destructive" part, we present a compendium of eighteen flaws associated with the IRR approach. In the "constructive" part, we construct the alternative approach from four (independent) economic intuitions and put the paradigm to the test by showing that it does not suffer from any of the flaws previously investigated. We also show how the IRR, as a rate of return, is absorbed into the new approach.

Studies on the Modifications and Applications of the Net Present Value and Internal Rate of Return

Proceedings of the 2022 6th International Seminar on Education, Management and Social Sciences (ISEMSS 2022), 2022

In terms of investment decision making, it is vital for the decision makers, to be able to select the investment project that is the most profitable. Therefore, various models are established including the net present value (NPV) and the internal rate of return (IRR) for the investors to compare different investment projects. In this paper, studies by scholars focusing on the advantages and disadvantages, and the modifications as well as applications of the NPV and IRR models are summarized and presented, along with further prediction of future market situations. Studies have also suggested that the prediction of cost of capital has to be carefully taken into consideration in NPV, and the pitfalls of IRR when encountering non-conventional cash flows which multiple numbers of IRR may be attained. In addition, further studies have shown that the feasibility of NPV and IRR are limited, due to the non-conventional cash flow, thus several modified versions of NPV and IRR were constructed including Max-NPV, Decouple NPV, Modified IRR, and Average IRR. Moreover, this paper analyses the improvements among the amendments upon the two models, by eliminating the problems of inconsistencies of NPV and IRR; case studies are also discussed to clarify the practical uses of the modified versions. Despite the coherent results obtained from the calculations, analysis of individual investment projects should still be done, in order to work out the optimal decision.

Internal rate of return: Good and bad features, and a new way of interpreting the historic measure

Computers & Chemical Engineering, 2017

HIGHLIGHTS for: Internal Rate of Return-The Pluses and Minuses, etc.  IRR-most-used profitability measure, but nonlinear, non-analytic & w/o parameters.  Attempts to make IRR more useful/realistic actually have confused the situation.  Despite IRR's issues, a new measure, NPV%, can help yield more information.  E.g., effect of Enterprise ROR on NPV% can be interpreted wrt IRR (both fcns of ROIBT).  But, better approach is to use NPV% directly and obtain its many advantages.

A Probabilistic Internal Rate of Return: Theory and Illustration

The purpose of this paper is to provide a theoretical background on the internal rate of return (IRR), on the probabilistic IRR, and to present an illustration based upon both a Taylor series expansion and a Monte Carlo simulation. It is shown that Monte Carlo simulation results in a more precise outcome as compared to the theoretical expectations from a Taylor series expansion. This precision is more than twice in terms of the standard deviations of the IRR, and around six times more in terms of the standard errors of the IRR. Second, the distributions of the internal rate of return follow approximately a normal distribution, and this allows a sound basis for project appraisal and risk management. Third, the grand means of the internal rates of returns for all four cases considered are statistically insignificantly different from each other, as expected, and they are statistically insignificantly different from the average internal rate of return, obtained by discounting the mean amounts of the cash flows. Fifth, the standard deviations and the standard errors of the IRR are directly proportional to the assumed standard deviations of the cash flows.

Ranking Investments with Internal Rate of Return and Benefit - Cost Ratio: A Revision

2011

The purpose of this paper is to present a procedure to include the implicit assumptions of Net Present Value NPV in the Internal Rate of Return, IRR, and the profitability index (benefit-cost ratio B/CR). The resulting indicators are the weighted IRR (WIRR) and the expanded B/CR (EB/CR). These two desirability measures have the property to coincide with the NPV ranking for investment analysis and hence, will maximize value. Examples are presented.

Development of Internal Rate of Return (IRR) Calculator

NIPES Journal of Science and Technology Research, 2019

The analytical determination of internal rate of return (IRR) is computationally demanding and the computational labour tends to be compounded as the project life becomes longer. Although some commercial software exist for computing the IRR but such exist as mere products (computing aid) that never provide the fundamental theory upon which the calculation is moored or founded. As a result the user merely inputs the necessary data in the textbox, enter and a display appears showing the results; but that is just all. This paper goes beyond user-friendliness to seek to contribute to knowledge by demonstrating the plausibility of application of binomial theory and Newton-Raphson's equation to IRR calculation, an initiative that past studies have sparsely investigated. Further, the research objective is sharpened by the need to develop an easy-to-use IRR calculator. The theoretical development of the IRR calculator is rooted on Newton-Raphson's equation of Numerical Analysis and the computational scheme was programmed with Visual Basic.net 2010. Our results prove that the method advocated is sure fire and the computational accuracy, which could be approximated to the nearest one percent, is the first rate. A numerical illustration is presented. The method proposed in this study is presented in both illustrative and instructive ways thereby making the research outcome not only relevant for academic purpose but also ideally suited to industrial engineers and practising finance managers as their guide to necessary action.

Economic rates of return: an extension

Journal of Accounting and Public Policy, 2001

This paper extends the cash-based rate of return models of and by allowing two classes of assets and three classes of sources of funds. The use of debt as a source of funds permits a return on equity calculation. Subsequently, the return on equity calculation is modi®ed to obtain a return on total assets pro®tability measure. These extensions lead to a solution of the cash-¯ow observability problem ®rst noted by . A second analytical result shows an equivalence between the accounting rate of return and the estimated rate of return developed in this paper if a particular cash-¯ow pattern is used. Ó (B.L. Miller). 1 Situations which can require measures of pro®tability include antitrust litigation (Fisher and McGowan, 1983, p. 82), rate determination for regulated industries, evaluation of initial public oerings, and measuring the performance of management at the ®rm, division or project level. For some of these situations, market-based pro®tability measures may be available and sucient but for others regulators, creditors, and investors rely heavily on accounting-based measures.

Mathematical analysis of average rates of return and investment decisions: The missing link

The Engineering Economist, 2014

This paper expands Teichroew, Robichek and Montalbano's (TRM) (1965a,b) rate-ofreturn 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 N P V is decomposed into financing N P V and investment N P V . 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

A note on the sensitivity analysis of the internal rate of return

International Journal of Production Economics, 2012

In this note we discuss the sensitivity analysis of the internal rates of return (IRR). We show that the use of partial derivatives can be misleading in the identification of key drivers of an investment project's performance. To remedy this shortcoming, we propose the use of an alternative sensitivity measure called the Differential Importance Measure. The analysis shows that, even if the theoretical conditions for using the Net Present Value or the IRR as valuation criteria apply, the sensitivity analysis results for the two indicators may differ.