Growth Rate A Rate-of-Return Measure of Investment Efficiency
- E.C. Capen (Atlantic Richfield Co.) | R.V. Clapp (Atlantic Richfield Co.) | W.W. Phelps (Atlantic Richfield Co.)
- Document ID
- Society of Petroleum Engineers
- Journal of Petroleum Technology
- Publication Date
- May 1976
- Document Type
- Journal Paper
- 531 - 543
- 1976. Society of Petroleum Engineers
- 4.1.5 Processing Equipment, 4.1.2 Separation and Treating, 5.7.5 Economic Evaluations, 7.10 Capital Budgeting and Project Selection, 4.3.4 Scale
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What you always wanted to know about practical economics but were afraid to ask - with special emphasis on what to do if you have more opportunities than money. Simply choose those projects that maximize your future worth. Start by ranking the projects with investment efficiency, or its return counterpart growth rate.
Except for the oil finders' witching rods, perhaps no area of our business has more folk remedies than the management of our financial affairs. The industry has amassed numerous not-so-useful methods for assessing the worth of capital-investment projects. Therefore, we view our task as twofold: tear down some of the old; and rebuild with something better, a concept of dollar investment efficiency that may be new to many readers. Why tear down anything? If our industry intends to make headway against the cost-price currents, one sure way is to spend more wisely. Get a dollar's worth of work out of a dollar's worth of effort! Does this not happen now? We do not think so. As long as people feel comfortable measuring project attractiveness with payout. profit-to-investment ratio, and other old payout. profit-to-investment ratio, and other old standbys, we think improvement is possible. Our industry does not stand alone in its reliance on the less useful guides. A 1974 report by the Conference Board shows that 14 percent of the 136 companies in the study use payout as their exclusive yardstick. (The companies that participated in the survey covered a wide range of size and type of business.) Another 59 percent use payout as one of several yardsticks. "Simplicity and ease of understanding are among the principal attributes of this method according to its principal attributes of this method according to its advocates," says the report. One wonders whether the quest for simplicity has a reasonable payout. These indices, for all their past usefulness, do not provide a manager with the necessary guidance for using his investment dollars most efficiently. We offer a replacement that we call growth rate - not a panacea, but a definite step forward. The idea of growth rate has been floating around for some years. We have attempted to take the thoughts of several authors and meld them. In addition. we have set forth some practical applications of the method and tried to outline some spots where an unwary user can get bushwhacked. Besides explaining the concept, we examine some issues that are important to its application: (1) the problem of defining "investment," (2) choosing a discount problem of defining "investment," (2) choosing a discount rate, (3) accounting for a variable reinvestment rate, and (4) capital allocation. In all that follows, we have left out considerations of uncertainty. Not that risks are unimportant, but we believe that we first must understand how to deal with the future under the assumption of perfect certainty.
Technical and Philosophical Questions
Man still debates the relative mixture of an and science in the field of economics. We could devote our entire effort here to the science side-but that would be cheating. Economics is not used in a vacuum; it must coexist in a world of diverse opinion. We think that the psychology of the economic-analysis game plays a role just psychology of the economic-analysis game plays a role just as important as the manipulation of the numbers. So, now and ten we devote attention to people and our perception of the influence they exert on the evaluation task. perception of the influence they exert on the evaluation task. It all starts with this diverse opinion just mentioned.
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