Investment Evaluation Methods and Required Rate of Return in Finnish Publicly Listed Companies
LTA 1/04 •
P.
9– 2 4
EVA LILJEBLOM AND MIKA VAIHEKOSKI*
Investment Evaluation Methods and Required Rate of Return in Finnish Publicly Listed
Companies
ABSTRACT
Financial literature advocates the use of the Net Present Value method for the evaluation of investments. Its key parameter is the required rate of return on equity, which is to be calculated using the
Capital Asset Pricing Model or a similar model especially if the company is publicly listed. However, there is ample evidence on companies not necessarily utilizing the NPV method or the CAPM in their capital budgeting and investment evaluation processes. This paper presents results of a survey conducted among the companies listed on the Helsinki Stock Exchange. The results show that the Finnish companies still lag behind US and Swedish companies in their use of the NPV, and the IRR method, even though it has become more commonly used during the last ten years. CAPM is used in surprisingly few companies, and 27 percent of the companies have not even defined their required rate of return on equity.
Key words: investment, payback rule, IRR, NPV, WACC, CAPM, HEX
JEL Classification: G31
* We are grateful for valuable comments by two anonymous referees. Financial support from the Finnish Academy of Sciences (the LIIKE project) is gratefully acknowledged.
EVA LILJEBLOM, Professor • Hanken, Swedish School of Economics and Business Administration,
Department of Finance • e-mail: eva.liljeblom@shh.fi
MIKA VAIHEKOSKI, Assistant professor • Helsinki School of Economics, Department of Accounting and Finance • e-mail: mika.vaihekoski@hkkk.fi
9
LTA 1/04 • E. LILJEBLOM
AND
M. VAIHEKOSKI
1 BACKGROUND
Business schools have advocated the use of the net present value (NPV) criterion as the superior method for the companies’ investment evaluation. Similarly, the Capital Asset Pricing Model (CAPM) has been advocated as the premier method for setting the required rate of return for
P.
9– 2 4
EVA LILJEBLOM AND MIKA VAIHEKOSKI*
Investment Evaluation Methods and Required Rate of Return in Finnish Publicly Listed
Companies
ABSTRACT
Financial literature advocates the use of the Net Present Value method for the evaluation of investments. Its key parameter is the required rate of return on equity, which is to be calculated using the
Capital Asset Pricing Model or a similar model especially if the company is publicly listed. However, there is ample evidence on companies not necessarily utilizing the NPV method or the CAPM in their capital budgeting and investment evaluation processes. This paper presents results of a survey conducted among the companies listed on the Helsinki Stock Exchange. The results show that the Finnish companies still lag behind US and Swedish companies in their use of the NPV, and the IRR method, even though it has become more commonly used during the last ten years. CAPM is used in surprisingly few companies, and 27 percent of the companies have not even defined their required rate of return on equity.
Key words: investment, payback rule, IRR, NPV, WACC, CAPM, HEX
JEL Classification: G31
* We are grateful for valuable comments by two anonymous referees. Financial support from the Finnish Academy of Sciences (the LIIKE project) is gratefully acknowledged.
EVA LILJEBLOM, Professor • Hanken, Swedish School of Economics and Business Administration,
Department of Finance • e-mail: eva.liljeblom@shh.fi
MIKA VAIHEKOSKI, Assistant professor • Helsinki School of Economics, Department of Accounting and Finance • e-mail: mika.vaihekoski@hkkk.fi
9
LTA 1/04 • E. LILJEBLOM
AND
M. VAIHEKOSKI
1 BACKGROUND
Business schools have advocated the use of the net present value (NPV) criterion as the superior method for the companies’ investment evaluation. Similarly, the Capital Asset Pricing Model (CAPM) has been advocated as the premier method for setting the required rate of return for
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