How to Correctly Interpret, Apply, and Generalize the TRM Model: Some Guidelines for Real-Life Projects

Abstract

This paper explains how to correctly interpret, and apply the TRM model, named after Teichroew, Robichek, and Montalbano (1965a,b). In particular, it explicitly shows the relation among the three rates involved in the model, namely, the project investment rate (PIR), the project financing rate (PFR), the cost of capital (COC). Their role as drivers of value creation is analyzed in detail. The paper also shows how to remove the original stringent assumptions which makes this important model not adequate for use in real-life contexts. Specifically, we remove the assumption according to which PIR and PFR are constant and are mathematically derived assuming one of them is equal to the COC; we show that they are easily derived from the actual estimates of the project’s prospective revenues and costs, as weighted means of the period returns on capital. An average return on capital (ROC) will be shown to be the unique project rate of return.