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Aggregate Return On Investment for investments under uncertainty

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  • Magni, Carlo Alberto

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 IRR, Cash Multiple, and Profitability Index are provided.

Suggested Citation

  • Magni, Carlo Alberto, 2015. "Aggregate Return On Investment for investments under uncertainty," International Journal of Production Economics, Elsevier, vol. 165(C), pages 29-37.
    • Handle: RePEc:eee:proeco:v:165:y:2015:i:c:p:29-37
    DOI: 10.1016/j.ijpe.2015.03.010
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    Cited by:

    1. 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.
    2. Haktanır, Elif & Kahraman, Cengiz, 2023. "Intuitionistic fuzzy risk adjusted discount rate and certainty equivalent methods for risky projects," International Journal of Production Economics, Elsevier, vol. 257(C).
    3. Wilson, William W. & McKee, Greg & Nganje, William & Dahl, Bruce & Bangsund, Dean, 2017. "Economic Impact of USWBSI’s Scab Initiative to Reduce FHB," Agribusiness & Applied Economics Report 264672, North Dakota State University, Department of Agribusiness and Applied Economics.
    4. Cuthbert, James R. & Magni, Carlo Alberto, 2016. "Measuring the inadequacy of IRR in PFI schemes using profitability index and AIRR," International Journal of Production Economics, Elsevier, vol. 179(C), pages 130-140.
    5. 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) 15209, Universita di Modena e Reggio Emilia, Dipartimento di Economia "Marco Biagi".

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    More about this item

    Keywords

    Return On Investment; Net present value; Uncertainty; Ranking; Rate;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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