An Average-Based Accounting Approach to Capital Asset Investments: The Case of Project Finance

18 Pages Posted: 2 Feb 2015 Last revised: 6 Feb 2015

See all articles by Carlo Alberto Magni

Carlo Alberto Magni

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering)

Date Written: February 1, 2015

Abstract

Literature and textbooks on capital budgeting endorse net present value (NPV) and generally treat accounting rates of return as not being reliable tools. This paper shows that accounting numbers can be reconciled with NPV and fruitfully employed in real-life applications. Focusing on project finance transactions, an Average Return On Investment (AROI) is drawn from the pro forma financial statements, obtained as the ratio of aggregate income to aggregate book value. We show that such a metric correctly captures a project’s economic profitability, as long as it is compared with a comprehensive Weighted Average Cost of Capital that includes a correction factor that takes account of the capital foregone by the investors. In contrast to the internal rate of return, AROI is unique, and we provide an explicit functional relation that links it to the NPV. The approach holds for levered and unlevered projects, constant and nonconstant leverage ratios, and constant and nonconstant WACCs.

Keywords: Investment decisions, accounting, return on investment, average, value creation, project finance

JEL Classification: M41, G31, G11

Suggested Citation

Magni, Carlo Alberto, An Average-Based Accounting Approach to Capital Asset Investments: The Case of Project Finance (February 1, 2015). European Accounting Review, DOI: 10.1080/09638180.2015.1009143, Available at SSRN: https://ssrn.com/abstract=2558762

Carlo Alberto Magni (Contact Author)

Università degli studi di Modena e Reggio Emilia (UNIMORE) - School of Doctorate E4E (Engineering for Economics-Economics for Engineering) ( email )

Italy

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