This paper deals with capital budgeting decisions under uncertainty. We present an Aggregate Return On Investment (AROI), obtained as the ratio of total (undiscounted) cash flow to total invested capital and show that it is a genuine rate of return which, compared with the risk-adjusted cost of capital, correctly signals wealth creation. For choosing between two mutually exclusive projects, we derive an incremental AROI and an incremental risk-adjusted cost of capital, by means of which two unequal-risk projects can be correctly compared. Iterating the incremental procedure, we show that the AROI approach correctly ranks any bundle of different-risk competing projects. Relations with other criteria such as Modified Internal Rate of Return, Average Internal Rate of Return, Cash Multiple, and Profitability Index are provided. Theoretically, the AROI approach constitutes a link between arbitrage choice theory and corporate investment theory, and shows that explicit discounting is not necessary for measuring economic profitability. Practically, the AROI is a user-friendly, easy-to-compute rate of return derived from the same set of data required by the net present value (NPV). Also, it does not incur the difficulties met by the internal rate of return: in particular, it is unique and it is based on economically significant capital values (i.e., market-driven values). As such, the AROI significantly expresses the efficiency of the project's invested capital.

Aggregate return on investment for investments under uncertainty / Magni, C. A.. - In: INTERNATIONAL JOURNAL OF PRODUCTION ECONOMICS. - ISSN 0925-5273. - 165:(2015), pp. 29-37. [10.1016/j.ijpe.2015.03.010]

Aggregate return on investment for investments under uncertainty

Magni, C. A.
2015

Abstract

This paper deals with capital budgeting decisions under uncertainty. We present an Aggregate Return On Investment (AROI), obtained as the ratio of total (undiscounted) cash flow to total invested capital and show that it is a genuine rate of return which, compared with the risk-adjusted cost of capital, correctly signals wealth creation. For choosing between two mutually exclusive projects, we derive an incremental AROI and an incremental risk-adjusted cost of capital, by means of which two unequal-risk projects can be correctly compared. Iterating the incremental procedure, we show that the AROI approach correctly ranks any bundle of different-risk competing projects. Relations with other criteria such as Modified Internal Rate of Return, Average Internal Rate of Return, Cash Multiple, and Profitability Index are provided. Theoretically, the AROI approach constitutes a link between arbitrage choice theory and corporate investment theory, and shows that explicit discounting is not necessary for measuring economic profitability. Practically, the AROI is a user-friendly, easy-to-compute rate of return derived from the same set of data required by the net present value (NPV). Also, it does not incur the difficulties met by the internal rate of return: in particular, it is unique and it is based on economically significant capital values (i.e., market-driven values). As such, the AROI significantly expresses the efficiency of the project's invested capital.
165
29
37
Aggregate return on investment for investments under uncertainty / Magni, C. A.. - In: INTERNATIONAL JOURNAL OF PRODUCTION ECONOMICS. - ISSN 0925-5273. - 165:(2015), pp. 29-37. [10.1016/j.ijpe.2015.03.010]
Magni, C. A.
File in questo prodotto:
File Dimensione Formato  
1-s2.0-S092552731500078X-main.pdf

non disponibili

Tipologia: Versione dell'editore (versione pubblicata)
Dimensione 375.4 kB
Formato Adobe PDF
375.4 kB Adobe PDF   Visualizza/Apri   Richiedi una copia
Pubblicazioni consigliate

Caricamento pubblicazioni consigliate

Licenza Creative Commons
I metadati presenti in IRIS UNIMORE sono rilasciati con licenza Creative Commons CC0 1.0 Universal, mentre i file delle pubblicazioni sono rilasciati con licenza Attribuzione 4.0 Internazionale (CC BY 4.0), salvo diversa indicazione.
In caso di violazione di copyright, contattare Supporto Iris

Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/11380/1239475
Citazioni
  • ???jsp.display-item.citation.pmc??? ND
  • Scopus 11
  • ???jsp.display-item.citation.isi??? 7
social impact