Notes: Internal Rate of Return May Be Used to Define Initial Equity for Composite Rate-of-Return Analyses

Author: Harpole, George B.

Source: Forest Science, Volume 30, Number 4, 1 December 1984 , pp. 1096-1102(7)

Publisher: Society of American Foresters

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Abstract:

A project's internal rate of return (IRR) may be used to define an initial equity amount (IEA) which will yield a composite rate of return (CRR) approximately equal to the IRR of the project under a wide range of different intermediate borrowing (Ib) and reinvestment rates (Ir). Initial equity investment determines requirements for borrowing, as well as cash surpluses that become available for reinvestment. Consequently, there is always a unique IEA that will establish circumstances for normal projects where net interest is equal to zero for Ib = Ir = 0 or IRR, and is close to zero for Ib = Ir > 0, and IRR. Where borrowing and reinvestment rates are not equal, the amount of net interest will cause the CRR to vary correspondingly from the IRR, measuring the net gain or loss from a project's inherent earnings rate. Where IEA amounts other than an IRR-defined IEA are used, the CRR will vary from the IRR in weighted correspondence to the amounts and timing of net interest and net project earnings. Thus, to maximize returns on equity investment, the IRR may be used as a criterion for selection of projects to the point where their IRR-defined IEA's exhaust available risk capital. The CRR algorithm can be used to measure the net results of borrowing and reinvestment and to measure the amount of earnings that can be gained by leveraged financing when using other than IRR-defined IEA's. Forest Sci. 30:1096-1102.

Keywords: Borrowing; reinvestment rates

Document Type: Miscellaneous

Affiliations: Research Forester, Forest Products Laboratory, USDA Forest Service, P.O. Box 5130, Madison, WI 53705

Publication date: December 1, 1984

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  • Forest Science is a peer-reviewed journal publishing fundamental and applied research that explores all aspects of natural and social sciences as they apply to the function and management of the forested ecosystems of the world. Topics include silviculture, forest management, biometrics, economics, entomology & pathology, fire & fuels management, forest ecology, genetics & tree improvement, geospatial technologies, harvesting & utilization, landscape ecology, operations research, forest policy, physiology, recreation, social sciences, soils & hydrology, and wildlife management.
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