Abstract

http://ssrn.com/abstract=1498106
 
 

Citations (1)



 
 

Footnotes (18)



 


 



Accounting and Economic Measures: An Integrated Theory of Capital Budgeting


Carlo Alberto Magni


University of Modena and Reggio Emilia - Department of Economics

November 1, 2009


Abstract:     
Accounting measures are traditionally considered not significant from an economic point of view. In particular, accounting rates of return are often regarded economically meaningless or, at the very best, poor surrogates for the IRR, which is held to be “the” economic yield. Likewise, residual income does not enjoy, in general, periodic consistency with the project NPV, so residual income maximization is not equivalent to NPV maximization. This paper shows that the opposition accounting/economic is artificial and, taking a capital budgeting perspective, illustrates the strong (formal and conceptual) connections existing between economic measures and accounting measures. In particular, the average accounting rate of return is the correct economic yield of a project; the traditional IRR is (whenever it exists) only a particular case of it. The average accounting rate generates a decision rule which is logically equivalent to the NPV rule for both accept/reject decisions and project ranking. The paper also shows that maximization of the simple arithmetic mean of residual incomes is equivalent to NPV maximization, owing to its periodic consistency in the sense of Egginton (1995). Such an index may then be used for incentive compensation as well. Moreover, asset pricing may be interpreted in accounting terms as the process whereby the market determines the income impact on the assets’ value. As a result, the paper harmonizes the notions of accounting rate of return, internal rate of return, residual income, net present value: they are just different ways of cognizing the same notion. This conciliation stems in a rather natural way from three sources: (i) a fundamental accounting identity, which links income and cash flow in a comprehensive way, (ii) the definition of Chisini mean, (iii) a notion of residual income which takes account of the “real” (comprehensive) cost of capital.

Number of Pages in PDF File: 48

Keywords: capital budgeting, accounting rate of return, economic yield, internal rate of return, residual income, net present value, average, Chisini mean, cost of capital

JEL Classification: M41, G11, G12, G31, D81, M52

working papers series


Download This Paper

Date posted: November 1, 2009 ; Last revised: July 23, 2011

Suggested Citation

Magni, Carlo Alberto, Accounting and Economic Measures: An Integrated Theory of Capital Budgeting (November 1, 2009). Available at SSRN: http://ssrn.com/abstract=1498106 or http://dx.doi.org/10.2139/ssrn.1498106

Contact Information

Carlo Alberto Magni (Contact Author)
University of Modena and Reggio Emilia - Department of Economics ( email )
Viale Berengario 51
Modena, Modena 41121
Italy
Feedback to SSRN


Paper statistics
Abstract Views: 4,834
Downloads: 914
Download Rank: 12,671
Citations:  1
Footnotes:  18

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo2 in 0.281 seconds