Mathematical Analysis of Average Rates of Return and Investment Decisions: The Missing Link
The Engineering Economist, 59(3), 175-206.
43 Pages Posted: 8 Jan 2014 Last revised: 14 Nov 2014
Date Written: September 18, 2014
This paper expands Teichroew, Robichek and Montalbano's (TRM) (1965a, b) rate-of-return 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 NPV is decomposed into financing NPV and investment NPV. 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 shown: the link between them is obtained by making use of the mean operator (i.e., an affine combinations of rates) and via the one-to-one correspondence between rates and invested capitals.
Keywords: investment analysis, rate of return, net present value, financing, average
JEL Classification: C60, D00, D4, E22, G11, G12, G31, O16, O22
Suggested Citation: Suggested Citation