Economic rates of return: an extension Kirsten M. Ely a , Bruce L. Miller b, * a DuPree College of Management, Georgia Institute of Technology, Atlanta, GA 30332-0520, USA b Department of Accounting, Anderson Graduate School of Management, Univerisity of California at Los Angeles, 110 Westwood Plaza, Suite D-409, Los Angeles, CA 900095-1481, USA Abstract This paper extends the cash-based rate of return models of Ijiri 1978) and Salamon 1982) by allowing two classes of assets and three classes of sources of funds. The use of debt as a source of funds permits a return on equity calculation. Subsequently, the return on equity calculation is modi®ed to obtain a return on total assets pro®tability measure. These extensions lead to a solution of the cash-¯ow observability problem ®rst noted by Stark 1987). A second analytical result shows an equivalence between the accounting rate of return and the estimated rate of return developed in this paper if a particular cash-¯ow pattern is used. Ó 2001 Elsevier Science Ltd. All rights reserved. 1. Introduction One of the uses of accounting is to measure the rate of return of a ®rm and its investment centers. 1 Remarking on his celebrated monograph with A.C. Littleton, An Introduction to Corporate Accounting Standards Paton and Littleton, 1940), Paton 1980, p. 630) comments that the work did not ``call Journal of Accounting and Public Policy 20 2001) 1±26 www.elsevier.com/locate/jaccpubpol * Corresponding author. Tel.: +1-310-825-1814; fax: +1-310-267-2193. E-mail address: bruce.miller@anderson.ucla.edu B.L. Miller). 1 Situations which can require measures of pro®tability include antitrust litigation Fisher and McGowan, 1983, p. 82), rate determination for regulated industries, evaluation of initial public oerings, and measuring the performance of management at the ®rm, division or project level. For some of these situations, market-based pro®tability measures may be available and sucient but for others regulators, creditors, and investors rely heavily on accounting-based measures. 0278-4254/01/$ - see front matter Ó 2001 Elsevier Science Ltd. All rights reserved. PII:S0278-425400)00023-5