Download This PaperProject Appraisal and the Intrinsic Rate of Return
4th International Conference on Production Economics and Project Evaluation, ICOPEV, Guimaraes, Portugal, September 20-21.
6 Pages Posted: 16 Oct 2018 Last revised: 30 Apr 2020
Date Written: July 18, 2018
Abstract
Building upon Magni (2011)’s approach, we propose a new rate of return measuring a project’s economic profitability. It is called the intrinsic rate of return (IROR). It is defined as the ratio of project return to project’s intrinsic value. The IROR approach decomposes the NPV into project scale and economic efficiency. In particular, NPV is found as the product of the project’s total invested capital and the excess rate of return, obtained as the difference between the IROR and the minimum attractive rate of return (MARR). This approach provides correct project ranking and is capable of managing time-varying costs of capital. In case of levered projects, shareholder value creation is captured by the equity IROR, which we call Intrinsic Return On Equity (IROE) (net income divided by total equity capital invested). If the project is unlevered, the IROE and the IROR lead to the same decision; if the project is levered, and the nominal value of debt is not equal to the market value of debt, the IROE should be preferred to project IROR.
Keywords: investment decisions, value creation, NPV-consistent decision-making, rate of return, intrinsic
JEL Classification: G11, G12, G30, G31, M41
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