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

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  • Carlo Alberto Magni

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.

Suggested Citation

  • Carlo Alberto Magni, 2014. "An average-based accounting approach to capital asset investments: The case of project finance," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0047, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    • Handle: RePEc:mod:wcefin:0047
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    6. Magni, Carlo Alberto, 2010. "Residual income and value creation: An investigation into the lost-capital paradigm," European Journal of Operational Research, Elsevier, vol. 201(2), pages 505-519, March.
    7. Fábio Frezatti & Diógenes de Souza Bido & Ana Paula Capuano Da Cruz & Marcelo Francini Girão Barroso & Maria José de Camargo Machado, 2013. "Investment Decisions on Long-term Assets: Integrating Strategic and Financial Perspectives," European Accounting Review, Taylor & Francis Journals, vol. 22(2), pages 297-336, June.
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    Cited by:

    1. Elisabetta Gualandri & Mario Noera, 2014. "Towards A Macroprudential Policy In The Eu: Main Issues," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0049, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    2. Magni, Carlo Alberto, 2016. "Capital depreciation and the underdetermination of rate of return: A unifying perspective," Journal of Mathematical Economics, Elsevier, vol. 67(C), pages 54-79.
    3. Elena Giarda & Gloria Moroni, 2018. "The Degree of Poverty Persistence and the Role of Regional Disparities in Italy in Comparison with France, Spain and the UK," Social Indicators Research: An International and Interdisciplinary Journal for Quality-of-Life Measurement, Springer, vol. 136(1), pages 163-202, February.
    4. Beatrice Bertelli & Gianna Boero & Costanza Torricelli, 2021. "The market price of greenness A factor pricing approach for Green Bonds," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0083, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    5. Elena Giarda & Gloria Moroni, 2018. "The Degree of Poverty Persistence and the Role of Regional Disparities in Italy in Comparison with France, Spain and the UK," Social Indicators Research: An International and Interdisciplinary Journal for Quality-of-Life Measurement, Springer, vol. 136(1), pages 163-202, February.
    6. Dean Altshuler & Carlo Alberto Magni, 2015. "Introducing Aggregate Return on Investment as a Solution to the Contradiction Between Some PME Metrics and IRR," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0056, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    7. Massimo Baldini & Giovanni Gallo & Costanza Torricelli, 2017. "Past Income Scarcity and Current Perception of Financial Fragility," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0064, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    8. Chiara Pederzoli & Costanza Torricelli, 2019. "The impact of the Fundamental Review of the Trading Book: A preliminary assessment on a stylized portfolio," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0075, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    9. Carlo Alberto Magni, 2015. "Pseudo-naïve approaches to investment performance measurement," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0051, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    10. Elisabetta Gualandri & Mario Noera, 2014. "Monitoring Systemic Risk: A Survey Of The Available Macroprudential Toolkit," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0050, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    11. Elisabetta Gualandri & Mario Noera, 2014. "Towards A Macroprudential Policy In The Eu: Main Issues," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 14110, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    12. Carlo Alberto Magni, 2015. "Pseudo-naïve approaches to investment performance measurement," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 15021, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    13. Pengran Zhou & Pengfei Zhou & Serhat Yüksel & Hasan Dinçer & Gülsüm Sena Uluer, 2019. "Balanced Scorecard-Based Evaluation of Sustainable Energy Investment Projects with IT2 Fuzzy Hybrid Decision Making Approach," Energies, MDPI, vol. 13(1), pages 1-20, December.
    14. Massimo Baldini & Giovanni Gallo & Costanza Torricelli, 2017. "Past Income Scarcity and Current Perception of Financial Fragility," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 17121, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    15. Stefano Cosma & Francesca Pancotto & Paola Vezzani, 2018. "Customer Complaining and Probability of Default in Consumer Credit," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 18031, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    16. Elisabetta Gualandri & Mario Noera, 2014. "Monitoring Systemic Risk: A Survey Of The Available Macroprudential Toolkit," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 14111, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    17. Enrico Rubaltelli & Sergio Agnoli & Michela Rancan & Tiziana Pozzoli, 2015. "Emotional Intelligence and risk taking in investment decision-making," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 15107, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    18. Enrico Rubaltelli & Sergio Agnoli & Michela Rancan & Tiziana Pozzoli, 2015. "Emotional Intelligence and risk taking in investment decision-making," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0053, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    19. Francesca Arnaboldi, Francesca Gioia, 2019. "Portfolio choice: Evidence from new-borns," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0078, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".
    20. Stefano Cosma & Francesca Pancotto & Paola Vezzani, 2018. "Customer Complaining and Probability of Default in Consumer Credit," Centro Studi di Banca e Finanza (CEFIN) (Center for Studies in Banking and Finance) 0068, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".

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    More about this item

    Keywords

    Return On Investment; capital budgeting; lost capital; average; financial accounting; project finance;
    All these keywords.

    JEL classification:

    • M4 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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