Return on Investment and the Fatal Flaw

by Herbert Kierulff



Over the past several decades a substantial body of theory has been developed on the subject of return on investment (ROl) and investment decisions in the firm. The attractiveness of a potential investment depends upon its net cash returns discounted over time by an appropriate cost of capital. Businessmen tend not to make investment choices according to the theory, although the internal rate of return or net present value is frequently calculated. Since only a small minority of investment decisions actually turns on ROl, it would seem desirable to examine alternative approaches to explain and predict investment behavior. A project flaw may be defined as a condition or set of conditions that make a project unattractive to the investor. If a flaw is serious enough to justify the rejection of a project, it is considered a fatal flaw. If a fatal flaw is uncovered during the course of investigation, the opportunity is either bypassed or refashioned along more acceptable lines. If a fatal flaw is not found, the merits and costs of the project are compared with other investment opportunities.

California Management Review

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