A NOTE ON ESTIMATING THE INTERNAL RATE OF RETURN FROM PUBLISHED FINANCIAL STATEMENTS

A method is presented for estimating the long-run profitability of a firm when only published financial statements are available. The model for estimating the internal rate of return (IRR) from such statements arises by considering a polynomial -- the fundamental valuation polynomial. A recursive fo...

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Bibliographic Details
Published in:Journal of business finance & accounting 1986-03, Vol.13 (1), p.1-13
Main Author: Steele, Anthony
Format: Article
Language:English
Subjects:
Applications
Cash flow
Economic theory
Estimating techniques
Financial analysis
Financial statements
Internal rate of return
Net present value
Rates of return
Statistical analysis
Studies
Theory
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Summary:A method is presented for estimating the long-run profitability of a firm when only published financial statements are available. The model for estimating the internal rate of return (IRR) from such statements arises by considering a polynomial -- the fundamental valuation polynomial. A recursive form is derived for identifying the IRR as a root of this polynomial, and the conditions for convergence of this recursive form are given. The method is applied to the published accounts of the UK firm Bridon Ltd. Financial statements for the years 1969-1980 are used in estimating the IRR. Analysis also explores the empirical importance of the valuation error term. The recursive model is modified to include the situation in which market values are available. However, in such situations, accounting information clearly is redundant for computing IRRs. Accounting-based return numbers are best seen as another type of pseudo price, of greatest practical value in the absence of market information.
ISSN:0306-686X
1468-5957
DOI:10.1111/j.1468-5957.1986.tb01169.x