A Simulation Assessment of Three Methods for Deriving the Long-run
Profitability of the Firm as its Internal Rate of Return
Timo Salmi and Ilkka Virtanen
Abstract
Three long-term profitability estimation methods, Kay's, Ijiri's and the
average accountant's rate of return method are evaluated using simulated
financial statements. It is observed that the methods are disrupted by large
deviations between growth and profitability, but are insensitive to cyclical
fluctuations. The numerical performance of the methods is roughly at par, but
Ijiri's method is more unpredictable than the theoretically better founded
Kay's method. The average accountant's rate of return method fares almost as
well as Kay's method, and can be recommended for financial analysis because
it is based on well-established accounting practice.
Key words: Long-term profitability, accountant's rate of return, internal
rate of return, IRR estimation models, simulation.
The Finnish Journal of Business Economics Vol. 46 (1997), No 3, 256-
281.