Financial Evaluation of Projects
There are several methods employed in assessing the profitability of capital expenditure on projects. The principal methods are:
1) Pay-back period method:- Pay-back period refers to the time taken to recover the initial investment in a project.
Pay-back period = Original cost of investment/Annual net cash inflows
Accept/Reject criterion: If the pay-back period is lower than the cut-off period, then the project will be considered for acceptance.
Pay-back period < Cut-off period Accept
Pay-back period > Cut-off period Reject
The main disadvantage of this method is that it does not take into account the time value of money.
2) Accounting Rate of Return
This method is also called as average rate of return method.
ARR = Average annual profits after taxes and depreciation x 100
Average investment over the life of the project
Accept/Reject Criterion:
ARR > Desired rate/cut-off rate -> Accept
ARR < Desired rate/cut-off rate -> Reject
Time value of money is not considered in this method also.
3) Net Present Value method (NPV)
Net Present Value is the difference between the present values of all the cash outflows and present values of all the cash inflows.
Accept/Reject criterion:
If NPV > 0, Accept
If NPV < 0, Reject.
This method takes into account the time value of money.
4) Internal rate of return method (IRR)
Internal rate of return is that rate which discounts the cash flows to zero.
Accept/Reject Criterion:
If IRR > Desired rate/cut-off rate -> Accept.
If IRR < Desired rate/cut-off rate -> Reject.
This method takes into account the time value of money.
Example: Pay-back period calculation
Given :
|
|
Project 1
|
Project 2
|
Project 3
|
|
Initial Inv.
|
40000
|
40000
|
40000
|
|
Year
|
Cash
|
Inflows
|
|
|
1
|
13000
|
7000
|
19000
|
|
2
|
13000
|
10000
|
16000
|
|
3
|
13000
|
13000
|
13000
|
|
4
|
12000
|
16000
|
11000
|
|
5
|
12000
|
18000
|
5000
|
Project 1 : 3 years and 1000/12000 years
(or) 3 years and 1 month.
Project 2: 3 and 10000/16000*12 years
3 years 7.5 months.
Project 3: 2 and 5000/13000 * 12 years
2 years and 4.6 months
Decision: Project 3 will be accepted as its pay-back period is shorter than the other two projects.
Financial Evaluation of Projects Tutoring & Assignment Help at
www.theglobaltutors.com
We provide Financial Evaluation of Projects Online Tutoring & Assignment Help /Homework Help at www.theglobaltutors.com. If you require One on One online session on Financial Evaluation of Projects, please send a mail to
support@theglobaltutors.com
and mention your schedule. We will then arrange for a session according to your time convenience. If you require Assignment Help and Homework Help on Financial Evaluation of Projects, please submit your assignments and home works at the “Submit Assignment”
section of our website or send a mail to cs@theglobaltutors.com,
with a mention of your deadline. Our panels of tutors are well qualified and experienced to handle any type of query in Financial Evaluation of Projects.
|
|