Horti-Business Management (2+0)

Project Evaluation measures

• The methods/criteria more often used for evaluating a project are
1. Simple rate of return (SRR)
2. Payback Period (PBP)
3. Benefit Cost Ratio (BCR)
4. Net present Value (NVP) or Net Present Worth (NPW) and
5. Internal Rate of Return (IRR).
• The SRR and the PBP are the undiscounted measures while BCR, NPV and IRR are the discounted measures of project worth of Investment.
1. Simple Rate of Return

• The SRR is a commonly used criterion of project evaluation. It basically expresses the average net profits (Net Cash Flows) generated each year by an investment as a percentage of investment over the investment’s expected life. It is as
SRR = Y/I

Where

Y = the average annual net profit (after allowing depreciation) from the investment
I = the initial investment

• The calculated SRR should be compared with the investor’s Required Rate of Return (RRR) to judge the profitability of the investment. The investment will be accepted if SRR > RRR, otherwise it will be rejected.
2. Pay Back Period (PBP)

• The Payback period is the length of time required for an investment to pay itself out. It is computed as
PBP = I/E

• When the projected net cash flows (E) are uniform or
n
PBP = I / Σ En = 1
t=1

• When the projected net cash flows are non-uniform.
Where,

I = the initial investment.
E = the projected net cash flows per year from the investment.
PBP = Pay Back Period expressed in number of years.

• Individual investments are ranked according to their relative payback period with the shortest being the most favored.
3. Benefit Cost Ratio (BCR)

• It is the ratio of present worth of benefit stream to present worth of cost stream i.e.,
Sum of the present worth of benefit

BCR = _______________________________

Sum of the present worth of cost

• Mathematically, it can be shown as
n
Σ Bn / (1 + i)n
t=1

BCR = ________________________

n
Σ Cn / (1 + i)n
t=1

Where,

Bn = Benefit in each year
Cn = Cost in each year
n = number of year
i = interest (discount) rates.

• The investment is said to be profitable when the BCR is one or greater than 1. This method is widely used in economic analysis and not in private investment analysis.
4. Net Present Value (NVP)

• Net present value is computed by finding the difference between the present worth of benefit stream less the present worth of cost stream. Or it is simply the present worth of the cash flow stream since it is a discounted cash flow measure of project worth along with internal rate of return.
• NPV = Present worth of Benefit Stream – Present Worth of Cost Stream.
• Mathematically, it can be shown as


• Or NPV = Present worth of the cash flow stream.
• The project is profitable or feasible if the calculated NVP is positive when discounted at the opportunity cost of capital.
5. Internal Rate of Return (IRR)

• Internal Rate of Return (IRR) is that discount rate which just makes the net present value (NVP) of the cash flow equal zero. It is considered to be the most useful measure of project worth and used by almost all the institutions.
• Mathematically,
• IRR is that discount rate ‘i’ such that
n
Σ (Bn - Cn) / (1 + i)n = 0 i.e. NVP = 0
t=1

Where

Bn = Costs in each year of the project.
Cn = Costs in each year of the project.
n = number of years in the project.
i = interest (discount) rate.

• A project is profitable or feasible for investment when the internal rate of return is higher than the opportunity cost of capital.