Munich Personal RePEc Archive

Measuring performance and valuing firms: In search of the lost capital

Magni, Carlo Alberto (2007): Measuring performance and valuing firms: In search of the lost capital.

There is a more recent version of this item available.
[thumbnail of MPRA_paper_5850.pdf]

Download (296kB) | Preview


Residual income as commonly described in academic papers and in real-life applications may be formally described as a function of three variables: (i) the capital invested, (ii) the rate of return, (iii) the opportunity cost of capital. This paper shows that a different paradigm of residual income is generated if a fourth element is added: (iv) the capital that investors lose if they infuse their funds into the firm (or project). The lost-capital paradigm has various interesting economic, nancial, accounting interpretations and bears intriguing formal and conceptual relations to the standard paradigm. It may be soundly employed in real-life applications as a tool for rewarding managers as well as for appraising firms. Firm value is shown to be a function of total abnormal earnings and independent of time, if the new paradigm is used: what matters is only the book value and the sum of total expected residual incomes, not the periods in which they are generated. This aggregation property is particular important for highlighting the link between accounting values and market values. A numerical example illustrates the practical implementation of the new paradigm to the Economic Value Added and the Edwards-Bell-Ohlson model; also, a model is presented which has the nice property of being aligned in sign with the Net Present Value: this makes it a good candidate for use in value-based management.

Available Versions of this Item

Atom RSS 1.0 RSS 2.0

Contact us: mpra@ub.uni-muenchen.de

This repository has been built using EPrints software.

MPRA is a RePEc service hosted by Logo of the University Library LMU Munich.