Yksinkertainen on kaunista
(Simple is beautiful)
Pitkän aikavälin kannattavuuden estimointimenetelmien
simulointivertailu
(A simulation assessment of four long-term profitability
estimation methods)
Timo Salmi and Ilkka Virtanen
English abstract
Four methods for estimating the firm's long-term profitability as the
internal rate of return (IRR) of the firm's capital investments are revisited
and evaluated using simulated financial statements. The methods of Kay,
Ijiri-Salamon, Ruuhela and the averaged accountant's rate of return (average
ROI) are analyzed. Our findings indicate that the methods are disrupted by
large deviations between the firm's growth and profitability, but in most
cases they are insensitive to cyclical fluctuations and to major capital
investment shocks. Kay's method fares marginally best in numerical
performance, and it is theoretically very well founded. The average ROI
method comes a close second. The Ijiri-Salamon method fares reasonably well
numerically, but its error is unpredictable. Theoretically, it is the most
ad-hoc of the methods. Ruuhela's method has a strong theoretical background,
but when its strict assumption of steady state growth is violated, numerically
it fares the worst. In the literature's long-standing dispute about the valid
ity of the ROI as a proxy for the IRR, our simulation results strongly support
the school of thought siding with the validity. Our research conclusion is to
recommend applying the average ROI method in the practice of financial
analysis. It is in a class of its own as regards pragmatic applicability
because ROI is a central accounting concept.