An average-based accounting approach to capital asset investments: The case of project finance

Carlo Alberto Magni

Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) from Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi"

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. It is shown 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 which takes account of the capital foregone by the investors. Contrary to the Internal Rate of Return, AROI is unique and we provide an explicit functional relation which links it to the NPV. The approach holds for levered and unlevered projects, constant and non-constant leverage ratios, constant and non-constant WACCs.

Keywords: Return On Investment; capital budgeting; lost capital; average; financial accounting; project finance (search for similar items in EconPapers)
JEL-codes: G31 M4 (search for similar items in EconPapers)
Pages: pages 19
Date: 2014-09
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (18)

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Related works:
Journal Article: An Average-Based Accounting Approach to Capital Asset Investments: The Case of Project Finance (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:mod:wcefin:0047

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