Evaluation Techniques by miguel arreguin

Payback period:

arreguin15prepaoxford — 2024-03-20 03:25:13 UTC

What it consists of:

The payback period is a financial metric used to determine how long it takes to recoup the initial investment in a project or investment.

Calculation method:

the payback period is calculated by dividing the initial investment by the average annual cash flow of the project.

Advantages:

Easy to understand and calculate and it provides a quick assessment of liquidity and risk.

Disadvantages:

Ignores cash flows beyond the payback period and does not consider the time value of money.

Acceptance Terms:

In general, the shorter the repayment term, the better, but specific acceptance terms may vary depending on the organization and nature of the project.

Internal rate of return:

arreguin15prepaoxford — 2024-03-20 03:28:35 UTC

Its components: IRR is the discount rate that makes the net present value (NPV) of the project's cash flows equal to zero. It represents the expected return from the project.

How it is calculated:

The internal rate of return is calculated using iterative methods or financial calculators/software. This involves finding the coefficient that fits the NPV equation.

Advantages:

Given the time value of money, it provides a uniform return on the project, which is useful for comparing projects of different sizes.

Disadvantages: Manual calculations can be complex and, in some cases, may lead to multiple or no correct solutions.

Acceptance Rule: A project is generally accepted if its IRR is greater than the required rate of return or the organization's cost of capital.

Net present value:

arreguin15prepaoxford — 2024-03-20 03:31:57 UTC

What it consists of:

Net present value is a method of evaluating the profitability of an investment by comparing the present value of all expected cash inflows and outflows.

Calculation method:

The present value is calculated by subtracting the initial investment from the present value of the cash flows discounted at the required rate of return.

Advantages:

The time value of money is considered; all cash flows are taken into account during the life of the project and clear decision criteria are provided.

Disadvantages:

Requires estimate of discount rate and may be sensitive to changes in the discount rate or cash flow estimates.

Acceptance rules:

A project is usually accepted if its NPV is positive.

Profitability index:

arreguin15prepaoxford — 2024-03-20 03:35:57 UTC

What it says:

The profitability index, also known as the benefit-cost ratio, measures the present value of future cash flows relative to the initial investment.

How it is calculated:

PI is calculated by dividing the present value of the cash flows by the original investment.

Advantages:

Considers the time value of money and provides a relative measure of project profitability.

Acceptance rules:

If the PI of the project is greater than 1, it is generally accepted.