A review of: “REAL OPTIONS: MANAGERIAL FLEXIBILITY AND STRATEGY IN RESOURCE ALLOCATION ” BY LENOS TRIGEORGIS The MIT Press,ISBN: 0-262-20102-X., xiii + 427 pp. List: $52.95.

One of the more controversial aspects of a public utility rate case is the determination of the cost of equity component of the allowed return. In practice, the Capital Asset Pricing Model, CAPM, and the Discounted Cash Flow Model, DCF, are used for this purpose. The difficulties in using the CAPM have been documented elsewhere. This note examines the DCF model.

The DCF implicitly assumes that earnings and dividends are growing at a constant rate. When dividend changes are in discrete jumps, the underlying assumptions of the DCF model have been violated. This note derives a DCF model for dividend changes that occur in discrete jumps.     

A review of: “APPLIED ECONOMIC ANALYSIS FOR TECHNOLOGISTS,ENGINEERS, AND MANAGERS ” BY MICHAEL S. BOWMAN Prentice-Hall,Inc., Upper Saddle River,New Jersey, 1999, xii + 561 pp., ISBN: 0-13-375932-6, List: $76.75.

In their recent paper Tang and Tang (2003 Tang, S. L. and Tang, H. J. 2003. The variable financial indicator IRR and the constant economic indicator NPV.. The Engineering Economist, Vol. 48(No. 1): pp. 69–78. [Taylor &; Francis Online] , [Google Scholar], pp. 69–78) revive a longstanding controversy—net present value (NPV) versus internal rate of return (IRR)—by characterizing the NPV as an economic indicator and the IRR as a financial one. The paper implies that this distinction justifies ranking financial alternatives by ranking their IRRs. In the current article, it is argued that the direct IRR ranking does not necessarily provide the same evaluation environment—and therefore a fair comparison—for each alternative involved, and that the incremental ranking approach is needed to remedy this shortcoming. The article also points out that Tang and Tang's numerical examples of simple projects with one sign change in their cash flow patterns do not address the problem of multiple IRRs, which consequently renders Tang and Tang's ranking approach dysfunctional. It is demonstrated that the concept of a true rate of return, substituting for the non-performing IRR and applied in conjunction with the incremental approach, provides an adequate tool for ranking mutually exclusive projects or a project's technical or financial alternatives.     

A review of: “COST ESTIMATING”, Rodney Stewart,Second Edition,John Wiley and Sons,Inc., New York, 1991, xxi + 359pp., ISBN 0-471-85707-6. List $54.95

In a previous paper Khan and Fiorino analyzed four energy saving projects. They found that use of the Capital Asset Pricing model to account for risk implied that the projects’ required rates of return were less than the return on riskless assets. Effectively lie projects bad negative risk. These negatively with macro economic activity. The current paper has two objectives: (1) to show that cafes of negative risk are rare and unimportant, and (2) to show that the assumption of negative covariance between energy price and the level of economic activity is incorrect.     

A Review of: “MODELING THE SUPPLY CHAIN” BY JEREMY R SHAPIRO Duxbury Press,Pacific Grove,California, 2001, xv + 586 pp. ISBN 0-534-37363-1. List: $71.95.

In this paper, we measure economic profit in an inflationary environment. Inflation adjusted economic profit requires two principal alterations to Economic Value Added (EVA[rgrave]). First, because inflation increases the replacement cost of non-current assets above book value, one must make a downward adjustment to EVA[rgrave] to correctly measure economic profit. Second, we add a term to EVA[rgrave] to represent a manager's ability to increase product price as costs increase. This adjustment is positive because this ability adds value to a firm. When a firm's assets are largely current, the first adjustment is not necessary, and therefore, the second dominates. In this case, EVA[rgrave] underestimates economic profit. Economic profit remains positive when a firm's rate of return on invested capital, after tax and after depreciation, is less than the weighted average cost of capital by as much as the rate of inflation. Even when inflation is modest, unadjusted EVA[rgrave] has the potential to seriously misrepresent the operating performance of a firm.