Lindon J. Robison and Peter J. Barry
This paper demonstrates that present value (PV) models can be viewed as multiperiod extensions of accrual income statements (AISs). Failure to include AIS details in PV models may…
Abstract
Purpose
This paper demonstrates that present value (PV) models can be viewed as multiperiod extensions of accrual income statements (AISs). Failure to include AIS details in PV models may lead to inaccurate estimates of earnings and rates of return on assets and equity and inconsistent rankings of mutually exclusive investments. Finally, this paper points out that rankings based on assets and equity earnings and rates of return need not be consistent, requiring financial managers to consider carefully the questions they expect PV models to answer.
Design/methodology/approach
AISs are used to guide the construction of PV models. Numerical examples illustrate the results. Deductions from AIS definitions demonstrate the potential conflict between asset and equity earnings and rates of return.
Findings
PV models can be viewed as multiperiod extensions of AISs. Mutually exclusive rankings based on assets and equity earnings and rates of return need not be consistent.
Research limitations/implications
PV models are sometimes constructed without the details included in AISs. The result of this simplified approach to PV model construction is that earnings and rates of return may be miscalculated and rankings based as asset and equity earnings and rates of return are inconsistent. Tax adjustments for asset and equity earnings may be miscalculated in applied models.
Practical implications
This paper provides guidelines for properly constructing PV models consistent with AISs.
Social implications
PV models are especially important for small to medium size firms that characterize much of agricultural. Providing a model consistent with AIS construction principles should help financial managers view the linkage between building financial statements and investment analysis.
Originality/value
This is the first paper to develop the idea that the PV model can be viewed as a multiperiod extension of an AIS.
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Lindon J. Robison and Peter J. Barry
This paper aims to use coordinated financial statements' system properties that include exogenous and endogenous variables to answer important questions. These questions include…
Abstract
Purpose
This paper aims to use coordinated financial statements' system properties that include exogenous and endogenous variables to answer important questions. These questions include the following: What is the financial condition of the firm? What if there is a change in the firm's exogenous variable(s) – how will the financial condition of the firm change? And, how much of a change in the firm's exogenous variable(s) is required for the firm to reach its financial goal(s)?
Design/methodology/approach
This paper uses coordinated financial statements to construct solvency, profitability, efficiency, liquidity and leverage (SPELL) ratios to answer the question: what is the financial condition of the firm? It answers what-if questions by changing an exogenous variable(s) and recalculating SPELL ratios. It answers how-much questions by using Excel's Goal Seek algorithm to find the required change in an exogenous variable to reach a firm's goal.
Findings
The authors find that coordinated financial statements' system properties can be used to answer important what-is, what-if and how-much questions about the firm.
Research limitations/implications
The usefulness of coordinated financial statements' system properties to answer what-is, what-if and how-much questions about the firm depends – mostly on the accuracy of exogenous data used to represent the firm's external financial environment. Furthermore, the usefulness of what-if and how-much analysis depends on how appropriate the changes are in exogenous variables used to represent alternative scenarios.
Practical implications
Using coordinated financial statements' system properties to answer what-is, what-if and how-much questions provides the firm's financial manager the tools to not only asses the firm's current financial condition but also to assess its ability to respond to opportunities and threats posed by future scenarios.
Social implications
The ability to assess the financial condition of a firm and to assess its strengths and weaknesses in key to making sound financial decisions. In addition, the consistency imposed on coordinated financial statements makes it an effective tool for discovering errors in its data.
Originality/value
The authors know of no similar work.
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Lindon J. Robison, Peter J. Barry and Robert J. Myers
It is well known that internal rate of return (IRR) and net present value (NPV) rankings of mutually exclusive investments are sometimes inconsistent. This inconsistency, when it…
Abstract
Purpose
It is well known that internal rate of return (IRR) and net present value (NPV) rankings of mutually exclusive investments are sometimes inconsistent. This inconsistency, when it occurs, requires decision makers to choose between the two ranking methods. The purpose of this paper is to deduce sufficient conditions for consistent IRR and NPV investment rankings of mutually exclusive investments.
Design/methodology/approach
Deductive reasoning is used to obtain the sufficient conditions required for consistent rankings of mutually exclusive investments.
Findings
There are different sufficient conditions (methods) that can be used to resolve inconsistent IRR and NPV rankings. However, the different methods do not necessarily produce the same consistent rankings. In particular, different size adjustment methods and reinvestment rate assumptions can produce different IRR and NPV consistent rankings. This paper suggests the appropriate criteria for selecting a particular method for ranking mutually exclusive investments.
Research limitations/implications
Like all deduced models, the results apply only to the set of assumptions and preconditions adopted in the model. Furthermore, the application is to ranking mutually exclusive investments.
Practical implications
There is probably no other issue in the capital budgeting literature that has generated more attention and debate than the consistency (or lack thereof) between IRR and NPV rankings. This paper summarizes conditions that can be followed to resolve the conflict which should have near universal interest to those working in the capital budging area. This paper offers alternative methods for obtaining consistent IRR and NPV rankings which can be used to improve investment ranking decisions. The particular method used should depend on the decision environment. Guides for choosing the appropriate ranking method are described in the paper.
Social implications
Significant decisions, projects, and investments are evaluated using either IRR or NPV methods. This paper shows that existing evaluation methods can lead to sub-optimal investment choices and provides an improved framework that facilitates better investment choices. Lacking an understanding of the sufficient conditions for IRR and NPV consistency – means that resource allocations have been made to investments and projects that are not optimal.
Originality/value
To the best of the authors’ knowledge, the results are this paper have not been published nor are they available elsewhere. That said, this paper builds on important earlier work which is carefully cited and credited.
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The first Wisconsin Ph.D.s who came to MSU with an institutional bent were agricultural economists and included Henry Larzalere (Ph.D. 1938) whose major professor was Asher…
Abstract
The first Wisconsin Ph.D.s who came to MSU with an institutional bent were agricultural economists and included Henry Larzalere (Ph.D. 1938) whose major professor was Asher Hobson. Larzalere recalls the influence of Commons who retired in 1933. Upon graduation, Larzalere worked a short time for Wisconsin Governor Phillip Fox LaFollette who won passage of the nation’s first unemployment compensation act. Commons had earlier helped LaFollette’s father, Robert, to a number of institutional innovations.4 Larzalere continued the Commons’ tradition of contributing to the development of new institutions rather than being content to provide an efficiency apologia for existing private governance structures. He helped Michigan farmers form cooperatives. He taught land economics prior to Barlowe’s arrival in 1948, but primarily taught agricultural marketing. One of his Master’s degree students was Glenn Johnson (see below). Larzalere retired in 1977.