Premium
Concepts, Theory, and Techniques INFLATION, MAINTENANCE OF CAPITAL, AND THE IRR MODEL OF CAPITAL BUDGETING *
Author(s) -
Agrawal Surendra P.
Publication year - 1986
Publication title -
decision sciences
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.238
H-Index - 108
eISSN - 1540-5915
pISSN - 0011-7315
DOI - 10.1111/j.1540-5915.1986.tb00209.x
Subject(s) - capital budgeting , economics , internal rate of return , rate of return , cost of capital , inflation (cosmology) , modified internal rate of return , capital (architecture) , return of capital , return on capital , cash flow , earnings , monetary economics , return on investment , macroeconomics , finance , microeconomics , financial capital , capital formation , investment performance , profit (economics) , history , physics , archaeology , production (economics) , theoretical physics , debt
Businesses operating under inflationary conditions need capital‐budgeting models that help them judge the adequacy of returns on their investments and also allow them to keep capital intact by considering the erosive effects of inflation. The model proposed in this paper computes a modified internal rate of return (IRR); if cash inflows from a project are divided between earnings and recovery of capital, total recovery equals that amount which the capital‐budgeting concept adopted by the business specifies (such as the original investment in constant dollars or its replacement cost). Under this model, a project should be accepted only if this computed rate equals or exceeds a hurdle rate that consists of the inflation‐free rate of return plus the effect of inflation on such a return. Other modifications to the IRR model suggested in the literature do not completely satisfy the objective of capital budgeting under inflationary conditions.