8/14/2019 How to Appraise a Project

1/3

HOW TO APPRAISE A PROJECT AND ECONOMIC APPROACH

There are four types of measures are commonly used to evaluate the performance ofcompany subunits.

1. RETURN ON INVESTMENT2. RESIDUAL INCOME

3. ECONOMIC VALUE ADDED

4. RETURN ON SALES

Return on investment

ROI is an accounting measure of income divided by an accounting measure of investment

ROI = income/investment

ROI is most popular approach to measure performance for two reasons, it blends all the

ingredients of profitability revenues, cost, and investment into a single percentage and

it can be compared with the rate of return on opportunities inside and outside of thecompany.

RESIDUAL INCOME.

RI is an accounting measure of income minus a dollar amount for required return on an

accounting measure of investment.

RI income required rate of return * investment

Some companies favor the RI measure because managers will concentrate on maximizing

an absolute amount, such as dollar of RI rather than % or investment.

ECONOMIC VALUE ADDED

Economic value assed is a specific type of residual income calculation that has recentlyattracted considerable attention. EVA equals after-tax operating income the after tax

weighted average cost of capital multiplied by total assets minus current liabilities.

EVA = ATOI [ Weihhted acerage cocpt * [ total asstes c lab ]

RETURN ON SALES

The income to revenues ration often called ROS is frequently used financial performance

measure. ROS is one component of ROI in the Dupont method of profitability analysis

8/14/2019 How to Appraise a Project

2/3

Payback Period

How long will it take for the project to generate enough cash to pay for itself?

Discounted PaybackDiscounts the cash flows at the firms required rate of return.

Payback period is calculated using these discounted net cash flows.

Problems:Cutoffs are still subjective.

Still does not examine all cash flows.

Other Methods

1) Net Present Value (NPV)

the present value of an investment projects net cash flow minus the projects initial

cash flows NPV = the total PV of the annual net cash flows - the initial outlay.

2) Profitability Index (PI)the ratio of the PV of a projects future net cash flows to the projects initial cash outflow.

If PI is greater than or equal to 1, ACCEPT.

If PI is less than 1, REJECT.

3) Internal Rate of Return (IRR)IRR: the return on the firms invested capital. IRR is simply the rate of return that the firm earns on

its capital budgeting projects.

If IRR is greater than or equal to the required rate of return, ACCEPT.

If IRR is less than the required rate of return, REJECT.

Each of these decision-making criteria:Examines all net cash flows,

Considers the time value of money, and

Considers the required rate of return.

8/14/2019 How to Appraise a Project

3/3

Project Appraisal

Submitted By:

Muntazir Abbas

Dated: 27 oct 2009

Army Public College of Management Sciences

(APCOMS)