Accretive Investment

EPS maximizers invest in accretive projects that generate enough income next year to pay for their own short-term funding using the firm’s cheapest available source of capital (equity, debt, or cash). This is the max EPS analog to the positive-NPV rule. On a per-dollar basis, accretive projects have income yields above the firm’s financing yield. An IRR is a multiperiod generalization of the project’s income yield. A payback period is the project’s income yield expressed as a multiple. Growth stocks have earnings yields below the riskfree rate. These firms view equity financing as cheap and fund new projects by issuing shares even when cash is present. Value stocks have earnings yields above the riskfree rate. These firms borrow enough to make external financing (both equity and debt) look expensive compared to cash, giving them high investment-cash flow sensitivities. We find empirical support for our model’s predictions.