INDIAN INSTITUTE OF TECHNOLOGY ROORKEE

Economic Appraisal Techniques
PW‐FE‐AE
What is Appraisal?

• A valuation is an objective comparison with evidence from closely

comparable properties
• An appraisal is an estimation of investment worth to an investor by
determining its risk and return characteristics in relation to that investor

Market Valuation
Backward‐looking; analysis of past transactions

Appraisal of Worth Forward‐looking; forecast of cash‐flow

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Why Appraisal of a Project is Required
• Why Appraisal of a Project is Required
– Acquisition
• Purchasing a property is one of the key times that Appraisal is utilised
• Why will different parties pay different prices for the same building?
– Refurbishment/redevelopment
– Financing arrangements
– Ongoing performance
– Disposal

• Why Appraisal of a Property is Required

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Objective

• Understand the key elements of the Economic Appraisal process.

• Calculate, interpret, and evaluate the payback period.

• Calculate, interpret, and evaluate the net present value (NPV) and
economic value added (EVA)

• Calculate, interpret, and evaluate the internal rate of return (IRR).

• Use net present value profiles to compare NPV and IRR

techniques.

• Discuss NPV and IRR in terms of conflicting rankings and the

theoretical and practical strengths of each approach.

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Overview of Economic Appraisal 
Techniques: Steps in the Process
The Economic Appraisal Techniques consists of five steps:
1. Proposal generation. Proposals for new investment projects are made at
all levels within a business organization and are reviewed by finance
personnel.
2. Review and analysis. Financial managers perform formal review and
analysis to assess the merits of investment proposals
3. Decision making. Firms typically delegate capital expenditure decision
making on the basis of dollar limits.
4. Implementation. Following approval, expenditures are made and projects
implemented. Expenditures for a large project often occur in phases.
5. Follow-up. Results are monitored and actual costs and benefits are
compared with those that were expected. Action may be required if actual
outcomes differ from projected ones.

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Basic Terminology

• Independent versus Mutually Exclusive Projects

– Independent projects are projects whose cash flows are unrelated to (or
independent of) one another; the acceptance of one does not eliminate the
others from further consideration.

– Mutually exclusive projects are projects that compete with one another, so
that the acceptance of one eliminates from further consideration all other
projects that serve a similar function.

• Unlimited Funds versus Capital Rationing

– Unlimited funds is the financial situation in which a firm is able to accept all
independent projects that provide an acceptable return.

– Capital rationing is the financial situation in which a firm has only a fixed
number of dollars available for capital expenditures, and numerous projects
compete for these dollars.

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Basic Terminology

• Accept-Reject versus Ranking Approaches

– An accept–reject approach is the evaluation of capital expenditure

proposals to determine whether they meet the firm’s minimum
acceptance criterion.

– A ranking approach is the ranking of capital expenditure projects on

the basis of some predetermined measure, such as the rate of return.

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PRESENT WORTH METHOD OF COMPARISON

In this method of comparison, the cash flows of each alternative will be reduced to 
time zero by assuming an interest rate i. Then, depending on the type of decision, the 
best alternative will be selected by comparing the present worth amounts of the 
alternatives.

• In a cost dominated cash flow diagram, the costs (outflows) will be assigned with 
positive sign and the profit, revenue, salvage value (all inflows), etc. will be 
assigned with negative sign.
• In a revenue/profit‐dominated cash flow diagram, the profit, revenue, salvage 
value (all inflows to an organization) will be assigned with positive sign. The costs 
(outflows) will be assigned with negative sign. 
• In case the decision is to select the alternative with the minimum cost, then the 
alternative with the least present worth amount will be selected. On the other 
hand, if the decision is to select the alternative with the maximum profit, then the 
alternative with the maximum present worth will be selected.

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PRESENT WORTH METHOD OF COMPARISON

REVENUE‐DOMINATED CASH FLOW DIAGRAM

COST‐DOMINATED CASH FLOW DIAGRAM

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PRESENT WORTH METHOD OF COMPARISON
EXERCISE

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PRESENT WORTH METHOD OF COMPARISON
Solution In all the technologies, the initial outlay is assigned a negative sign and the annual 
revenues are assigned a positive sign.

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PRESENT WORTH METHOD OF COMPARISON

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PRESENT WORTH METHOD OF COMPARISON

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PRESENT WORTH METHOD OF COMPARISON
EXERCISE

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PRESENT WORTH METHOD OF COMPARISON
EXERCISE 1

EXERCISE 2

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FUTURE WORTH METHOD OF COMPARISON
In the future worth method of comparison of alternatives, the future worth of various alternatives 
will be computed. Then, the alternative with the maximum future worth of net revenue or with 
the minimum future worth of net cost will be selected as the best alternative for implementation.

REVENUE‐DOMINATED CASH FLOW DIAGRAM

COST‐DOMINATED CASH FLOW DIAGRAM

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FUTURE WORTH METHOD OF COMPARISON
EXERCISE 1

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FUTURE WORTH METHOD OF COMPARISON

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ANNUAL EQUIVALENT METHOD
In the annual equivalent method of comparison, first the annual equivalent cost or the revenue of 
each alternative will be computed. Then the alternative with the maximum annual equivalent 
revenue in the case of revenue‐based comparison or with the minimum annual equivalent cost in 
the case of cost based comparison will be selected as the best alternative.

REVENUE‐DOMINATED CASH FLOW DIAGRAM

COST‐DOMINATED CASH FLOW DIAGRAM

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ANNUAL EQUIVALENT METHOD

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ANNUAL EQUIVALENT METHOD

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