Accounting Measures and Economic Measures: An Integrated Theory of Capital Budgeting
Journal of Accounting and Finance, 19(9), 166‒208, 2019
45 Pages Posted: 23 Mar 2021
Date Written: 2019
Accounting measures are traditionally matched against economic measures. For example, accounting rates of return (ARR) are usually considered poor surrogates of the “economic rate of return” and the residual income is sometimes criticized as being periodically inconsistent with the net present value (NPV). This paper shows that the opposition accounting/economic is artificial and, taking a capital budgeting perspective, illustrates the strict links between economic measures and accounting measures. In particular, the ARR is shown to be a correct economic yield of a project and the traditional IRR is only a particular case of it. Also, maximization of the simple arithmetic mean of properly modified residual incomes is equivalent to NPV maximization, owing to its periodic consistency in the sense of Egginton (1995). The conciliation of such notions as NPV, IRR, ARR, and residual income stems from (i) the fundamental law of motion of any economic entity, (ii) the notion of Chisini mean, (iii) a modified notion of residual income which takes account of a comprehensive cost of capital.
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, G31
Suggested Citation: Suggested Citation