HOW TO APPRAISE A PROJECT AND – ECONOMIC APPROACH

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

1. RETURN ON INVESTMENT
2. 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 the
company.

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 recently
attracted 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
Payback Period

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

Discounted Payback
Discounts the cash flows at the firm’s 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 firm’s 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.
 Project Appraisal

Submitted By:

Muntazir Abbas

Dated: 27 oct 2009

Army Public College of Management Sciences

(APCOMS)