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Investment, financing and the role of ROA and WACC in value creation


  • Carlo Alberto Magni



Evaluating an industrial opportunity often means to engage in financial modelling which results in estimation of a large amount of economic and accounting data, which are then gathered in an economically rational framework: the pro forma financial statements. While the standard net present value (NPV) condenses all the available pieces of information into a single metric, we make full use of the crucial information supplied in the pro forma financial statements and give a more detailed account of how economic value is created. In particular, we construct a general model, allowing for varying interest rates, which decomposes the project into investment side and financing side and the value created by either side; an equity/debt decomposition is also accomplished, which enables to appreciate the role of debt in adding or subtracting value to equityholders. Further, the major role of accounting rates of return as value drivers is highlighted, and new relative measures of worth are introduced: the project ROA and the project WACC, which aggregate information deriving from the period rates of return. To achieve these results, we make use of the Average-Internal-Rate-of-Return (AIRR) approach, recently introduced, which rests on capital-weighted arithmetic means and sets a direct relation between holding period rates and NPV.

Suggested Citation

  • Carlo Alberto Magni, 2015. "Investment, financing and the role of ROA and WACC in value creation," Department of Economics 0050, University of Modena and Reggio E., Faculty of Economics "Marco Biagi".
  • Handle: RePEc:mod:depeco:0050

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    References listed on IDEAS

    1. Weingartner, H. Martin, 1966. "The Generalized Rate of Return," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 1(03), pages 1-29, September.
    2. Sandahl, Gert & Sjogren, Stefan, 2003. "Capital budgeting methods among Sweden's largest groups of companies. The state of the art and a comparison with earlier studies," International Journal of Production Economics, Elsevier, vol. 84(1), pages 51-69, April.
    3. Borgonovo, E. & Gatti, S. & Peccati, L., 2010. "What drives value creation in investment projects? An application of sensitivity analysis to project finance transactions," European Journal of Operational Research, Elsevier, vol. 205(1), pages 227-236, August.
    4. Carlo Alberto Magni, 2010. "Average internal rate of return and investment decisions: A new perspective," PROYECCIONES FINANCIERAS Y VALORACION 006653, MASTER CONSULTORES.
    5. Gallo, Paolo & Peccati, Lorenzo, 1993. "The appraisal of industrial investments: A new method and a case study," International Journal of Production Economics, Elsevier, vol. 30(1), pages 465-476, July.
    6. Magni, Carlo Alberto, 2009. "Splitting up value: A critical review of residual income theories," European Journal of Operational Research, Elsevier, vol. 198(1), pages 1-22, October.
    7. Wiesemann, Wolfram & Kuhn, Daniel & Rustem, Berç, 2010. "Maximizing the net present value of a project under uncertainty," European Journal of Operational Research, Elsevier, vol. 202(2), pages 356-367, April.
    8. Borgonovo, E. & Peccati, L., 2006. "The importance of assumptions in investment evaluation," International Journal of Production Economics, Elsevier, vol. 101(2), pages 298-311, June.
    9. Herroelen, Willy S. & Van Dommelen, Patrick & Demeulemeester, Erik L., 1997. "Project network models with discounted cash flows a guided tour through recent developments," European Journal of Operational Research, Elsevier, vol. 100(1), pages 97-121, July.
    10. Lindblom, Ted & Sjögren, Stefan, 2009. "Increasing goal congruence in project evaluation by introducing a strict market depreciation schedule," International Journal of Production Economics, Elsevier, vol. 121(2), pages 519-532, October.
    11. Borgonovo, E. & Peccati, L., 2004. "Sensitivity analysis in investment project evaluation," International Journal of Production Economics, Elsevier, vol. 90(1), pages 17-25, July.
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    13. Gatti, Stefano, 2012. "Project Finance in Theory and Practice," Elsevier Monographs, Elsevier, edition 2, number 9780123919465, August.
    14. Carlo Alberto Magni, 2012. "The Internal-Rate-of-Return approach and the AIRR paradigm: A refutation and a corroboration," PROYECCIONES FINANCIERAS Y VALORACION 010084, MASTER CONSULTORES.
    15. Remer, Donald S. & Stokdyk, Scott B. & Van Driel, Mike, 1993. "Survey of project evaluation techniques currently used in industry," International Journal of Production Economics, Elsevier, vol. 32(1), pages 103-115, August.
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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. Magni, Carlo Alberto & Veronese, Piero & Graziani, Rebecca, 2017. "Chisini means and rational decision making: Equivalence of investment criteria," MPRA Paper 81532, University Library of Munich, Germany.
    3. repec:eee:ejores:v:268:y:2018:i:1:p:361-372 is not listed on IDEAS
    4. Tao, Jacqueline Yujia & Finenko, Anton, 2016. "Moving beyond LCOE: impact of various financing methods on PV profitability for SIDS," Energy Policy, Elsevier, vol. 98(C), pages 749-758.
    5. Mørch, Ove & Fagerholt, Kjetil & Pantuso, Giovanni & Rakke, Jørgen, 2017. "Maximizing the rate of return on the capital employed in shipping capacity renewal," Omega, Elsevier, vol. 67(C), pages 42-53.
    6. repec:gam:jsusta:v:10:y:2018:i:6:p:2066-:d:153075 is not listed on IDEAS

    More about this item


    Value creation; net present value; Return On Assets; WACC; weighted mean; equity; debt;

    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
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C0 - Mathematical and Quantitative Methods - - General
    • D4 - Microeconomics - - Market Structure, Pricing, and Design
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting


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