Generalized Makeham's Formula and Economic Profitability

Carlo Alberto Magni

No 10992, Proyecciones Financieras y Valoración from Master Consultores

Abstract: This paper generalizes Makeham’s formula, allowing for varying interest rates and for a non-flat structure of valuation rates. An average interest rate (AIR) is introduced, as well as an average valuation rate (AVR), which exist and are unique for any asset. They can be computed either as principal-weighted arithmetic means or as interest-weighted harmonic means of period rates. Economic profitability of an asset or a portfolio of assets is captured by the spread between AIR and AVR, which has the same sign as the Net Present Value. This makes (i) AIR a more reliable tool for valuation and decision than the venerable Internal Rate of Return, and (ii) AVR a natural generalization of the cost-of-capital notion.

Keywords: Makeham’s formula; net present value; average interest rate; internal rate of return (search for similar items in EconPapers)
JEL-codes: G11 G12 G31 (search for similar items in EconPapers)
Pages: 23
Date: 2013-09-26
New Economics Papers: this item is included in nep-cfn
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Citations: View citations in EconPapers (5)

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http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2331259

Related works:
Journal Article: Generalized Makeham’s formula and economic profitability (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:col:000463:010992

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