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Accounting Rate
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Carlo Alberto Magni – One of the best experts on this subject based on the ideXlab platform.
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Chisini means and rational decision making: equivalence of investment criteria
Mathematics and Financial Economics, 2018Co-Authors: Carlo Alberto Magni, Piero Veronese, Rebecca GrazianiAbstract:A plethora of tools are used for investment decisions and performance measurement, including net present value, internal Rate of return, profitability index, modified internal Rate of return, average Accounting Rate of return. All these and other known metrics are generally considered non-equivalent and some of them are regarded as unreliable or even naïve. Building upon Magni (Eng Econ 55(2):150–180, 2010a , Eng Econ 58(2):73–111, 2013 )’s average internal Rate of return, we show that the notion of Chisini mean enables these tools to be used as rational decision criteria. Specifically, we focus on 11 metrics and show that, if properly used, they all provide equivalent accept–reject decisions and equivalent project rankings. Therefore, the intuitive notion of mean is the founding basis of investment decision criteria.
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economic profitability and the Accounting Rate of return
Proyecciones Financieras y Valoración, 2012Co-Authors: Carlo Alberto Magni, Ken V PeasnellAbstract:The internal Rate of return (IRR) is a widely used benchmark for assessing the reliability of the Accounting Rate of return (ROA) as a measure of economic profitability. We turn this reasoning process on its head by demonstrating that a suitable (weighted average) aggregation of ROAs better captures what is generally meant by economic profitability than does the IRR. We show that average ROA when compared with the cost of capital, will always correctly signal economic profitability in the sense that it will correspond exactly with what would be obtained from a net present value calculation. We also show that average ROA can be used to make meaningful inter-firm comparisons of profitability, when due allowance is made for differences in investment scale. Using this framework, we show how average ROA can be used to assess economic profitability for a truncated time series where the opening and closing capital stocks provided by the Accounting system do not adequately represent the firm´s initial and ending endowments of resources. Finally, we suggest how this approach can be put to practical use in assessing profitability of firms on an on-going basis.
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Accounting and Economic Measures: An IntegRated Theory of Capital Budgeting
SSRN Electronic Journal, 2009Co-Authors: Carlo Alberto MagniAbstract:Accounting measures are traditionally considered not significant from an economic point of view. In particular, Accounting Rates of return are often regarded economically meaningless or, at the very best, poor surrogates for the IRR, which is held to be “the” economic yield. Likewise, residual income does not enjoy, in general, periodic consistency with the project NPV, so residual income maximization is not equivalent to NPV maximization. This paper shows that the opposition Accounting/economic is artificial and, taking a capital budgeting perspective, illustRates the strong (formal and conceptual) connections existing between economic measures and Accounting measures. In particular, the average Accounting Rate of return is the correct economic yield of a project; the traditional IRR is (whenever it exists) only a particular case of it. The average Accounting Rate geneRates a decision rule which is logically equivalent to the NPV rule for both accept/reject decisions and project ranking. The paper also shows that maximization of the simple arithmetic mean of residual incomes is equivalent to NPV maximization, owing to its periodic consistency in the sense of Egginton (1995). Such an index may then be used for incentive compensation as well. Moreover, asset pricing may be interpreted in Accounting terms as the process whereby the market determines the income impact on the assets’ value. As a result, the paper harmonizes the notions of Accounting Rate of return, internal Rate of return, residual income, net present value: they are just different ways of cognizing the same notion. This conciliation stems in a rather natural way from three sources: (i) a fundamental Accounting identity, which links income and cash flow in a comprehensive way, (ii) the definition of Chisini mean, (iii) a notion of residual income which takes account of the “real” (comprehensive) cost of capital.
Gary Kelly – One of the best experts on this subject based on the ideXlab platform.
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time series and cross sectional dynamics of Accounting Rate of return and the prediction of cash flow per ordinary share
Accounting Accountability & Performance, 2009Co-Authors: Gary Kelly, Mohammad Iqbal TahirAbstract:This paper investigates the time series and cross-sectional behaviour of the Accounting Rate of Return (ARR) and tests whether ARR is a good predictor of the Cash Flow Per Share (CFPS). Both of these financial variables are of interest to investors, financial analysts and academic researchers. To address these research questions, we use the Butler, Holland and Tippett (1994) model and ordinary least squares regressions to a sample of 44 Australian firms for the period from 1970 to 1990. Time series results indicate that ARR follows a mean-reverting process at individual and aggregate levels, and that it is a poor predictor of CFPS. Cross-sectional results for ARR and CFPS suggest random processes without substantial drift patterns.
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Accounting and economic Rates of return: Additional Australian evidence
Journal of Accounting and Public Policy, 1996Co-Authors: Gary KellyAbstract:Abstract The key issue addressed in my paper is whether Accounting Rate of return (ARR) performs as an effective monitoring surrogate for internal Rate of return (IRR). Financial information derived from a sample of 44 Australian corporations between 1968 and 1990 was utilized to accomplish this objective. The Kelly-Tippett (1991) technique was employed to analyze the data set. Results confirm earlier work in the area in that the ARR was found to be an unreliable substitute for the IRR.
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Economic and Accounting Rates of Return A Statistical Model
Accounting and Business Research, 1991Co-Authors: Gary Kelly, Mark TippettAbstract:Abstract This paper develops a number of statistical procedures than can be used to determine whether a firm’s ex post Accounting Rate of return (ARR) is likely to provide guidance as to the economic return the firm will earn over its remaining life. The paper argues that if a corporation’s future process cash flows are geneRated by some form of stochastic process, then the probability density function induced by this can be used to assess whether the ARR provides a reasonable reflection of the economic return the corporation is likely to earn over its remaining life. Five large listed companies are used as case studies to illustRate the model’s application.
Mark Tippett – One of the best experts on this subject based on the ideXlab platform.
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Economic and Accounting (Book) Rates of Return: Application of a Statistical Model
Accounting and Business Research, 1994Co-Authors: David Butler, Kevin Holland, Mark TippettAbstract:Abstract Harcourt’s (1965) classic paper has spawned a considerable literature dealing with the relationship between economic and Accounting Rates of return. Kay (1976), Ijiri (1979), Salamon (1982) and Kelly and Tippett (1991), for example, can be interpreted as extensions of Harcourt’s seminal analysis, while Kay (1976), Salamon (1982, 1985) and Gordon and Hamer (1988) provide empirical evidence on the sustainability of basic propositions. The present paper’s focus is on the latter area; we apply the statistical procedures laid down in Kelly and Tippett (1991) to about 200 British companies to assess the correspondence between the ex post Accounting Rate of return and the prospective economic return. The economic return is estimated using three cash flow definitions. For all three, the Accounting Rate of return is significantly lower than the economic return. Further tests show the economic return to be inversely related to the Accounting Rate of return, although the relationship is weak. In addition, ‘…
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Economic and Accounting Rates of Return A Statistical Model
Accounting and Business Research, 1991Co-Authors: Gary Kelly, Mark TippettAbstract:Abstract This paper develops a number of statistical procedures than can be used to determine whether a firm’s ex post Accounting Rate of return (ARR) is likely to provide guidance as to the economic return the firm will earn over its remaining life. The paper argues that if a corporation’s future process cash flows are geneRated by some form of stochastic process, then the probability density function induced by this can be used to assess whether the ARR provides a reasonable reflection of the economic return the corporation is likely to earn over its remaining life. Five large listed companies are used as case studies to illustRate the model’s application.