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Company investment project evaluation methods
Mind map of company investment project evaluation methods. This map introduces dynamic and static indicators, net present value, internal rate of return, profit index, overdraft payback period, etc.
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Company investment project evaluation methods
- bacteria
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- Plant asexual reproduction
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- Reproductive development of animals
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Company investment project evaluation methods
Section 1 Evaluation Methods for Investment Projects
Dynamic and static indicators
Dynamic: Uniform conversion based on the time value of money
Static: Calculated directly based on the cash flow generated by the investment project
Net Present Value (NPV) method
meaning
A dynamic standard that reflects the profitability of an investment project during its construction and production service life.
The sum of the present values of net cash flows in each year during the entire construction and production service life calculated at a certain discount rate
Decision principles
When NPV≥0, the project is feasible;
When NPV＜0, the project is not feasible
The greater the net present value, the greater the priority.
Features of the Code
Net present value is additive
The net present value criterion assumes that a project will generate intermediate cash flows Amount that can be reinvested at a minimum acceptable rate of return
The NPV calculation takes into account changes in the expected term structure and interest rates
Current decision-making denies the flexibility of decision-making
Internal rate of return (IRR) method
Meaning: The discount rate when the project's net present value is zero or the discount rate when the present value of cash inflows is equal to the present value of cash outflows
calculate
Internal rate of return is different from cost of capital
IRR is calculated based on the cash flow of the project itself, reflecting the expected rate of return on project investment; capital cost is the minimum rate of return required by investors to invest in the project.
decision criteria
IRR≥project capital cost or minimum investment rate of return feasible
IRR＜Project capital cost or minimum investment rate of return Not feasible
Profit Index (PI)
meaning
Also known as the present value index, it refers to the ratio of the present value of future cash inflows to the present value of cash outflows of an investment project.
calculate
Decision principles
When PI≥1, the project is feasible
When PI＜1, the project is not feasible
evaluate
Advantages: The profit index is expressed as a relative number and can be compared between independent schemes with different investment amounts.
Disadvantages: Ignores differences in the scale of mutually exclusive projects and may draw conclusions different from net present values, misleading decision-making.
Payback period (PP)
Meaning: The time required to recover the initial investment through the project’s net cash flow
calculate
Decision principles
PP <Baseline Payback Period Accept
PP > Baseline Payback Period Give Up
evaluate
Advantages: simple method, intuitive reflection, wide application
shortcoming
① Failure to consider the time value of money and the risk value of investment;
② Ignore the cash flows after the payback period
Accounting rate of return (ARR)
Meaning: The ratio of the average annual net income of an investment project to the average annual investment amount of the project
calculate
Simple average calculation of the total net income in each year after the project is put into operation
Arithmetic mean of book value of fixed asset investments (Can also include working capital investment amount): This will be affected by the depreciation policy
Decision principles
If ARR > Baseline accounting rate of return, the plan should be accepted;
If ARR <base accounting rate of return, the plan should be abandoned.
Among the choices of multiple mutually exclusive plans, the project with the highest accounting rate of return should be selected.
evaluate
Advantages: concise, easy to understand, easy to calculate
shortcoming
① Failure to consider the time value of money and the risk value of investment
② Calculated based on the book value of an investment project, when there is an opportunity cost in the investment project, the judgment results are very different from standards such as net present value, and sometimes the opposite conclusion is reached.
Section 4 Risk Analysis of Investment Projects
Risk type
unique risks
corporate risk
market risk
Highly correlated
sensitivity analysis
meaning
Measure the impact of changes in uncertainty factors on evaluation criteria
Analysis purpose
Find out which factor table the profitability of an investment opportunity is sensitive to
Provide decision-makers with important decision-making information
Basic idea
If a factor related to decision-making changes, how will the NPV and IRR of the original plan be affected.
step
Determine sensitivity analysis objects
Choose uncertainty factors
Adjust cash flow
advantage
Be able to consider the risks that changes in different factors bring to investment projects
It is easy to find the factors that have a greater impact on investment projects and conduct detailed investigation and control.
shortcoming
Only changes in each factor are considered, and the interaction between factors is not considered.
May subjectively overestimate or underestimate changes in factors
Scenario analysis
Break-even analysis
accounting breakeven
Accounting break-even analysis determines the sales volume of a product or company at which revenue just covers costs, and the net income of the product or company is zero.
net present value breakeven
Net present value break-even analysis requires finding the sales volume when the future cash inflow of the investment exactly makes up for the cash outflow, that is, seeking the sales volume necessary when the net present value of the project is zero.
Decision tree analysis
A method of charting the cash flow sequence of investment projects
A method of charting the cash flow sequence of investment projects
Section 3 Cash Flow Estimation
cash flow CF
CF: The amount of cash actually received or paid for an investment project within a certain period of time
Net cash flow = cash inflow – cash outflow
Net cash flow (NCF) - the difference between cash inflows and cash outflows within a certain period of time
Cash outflow – additional cash outlays resulting from the investment
Cash inflow - the amount of cash income increased or cash expenditure saved due to the investment
1. Actual cash flow
When measuring the income and costs of investment projects, cash flow is used instead of accounting income. The future cash flows of the project must be calculated using expected future prices or costs, not current prices or costs.
2. Incremental cash flow
In capital budgeting analysis, only those projects that would have Cash flows that occur (or do not occur) are what should be included in the analysis
Division of investment project cash flows
Initial cash flow
Operating cash flow
Ending cash flow
Pay attention to the problem
Cash flow estimation example
Investment project decisions in different life cycles
Approximate annual average cost method: convert the net present value of the cost of each project into an annual average cost using the annuity formula
Section 2 Frequently Asked Questions in Investment Project Evaluation
Internal Rate of Return (IRR) and Unconventional Cash Flows
If there are multiple evaluations of internal rate of return projects, you may consider revising the internal rate of return.
Since the modified internal rate of return method requires the use of external discount rates, it destroys the essence of the internal rate of return calculation.
Essence: The internal rate of return is determined by the intrinsic value of the project.
Independent and mutually exclusive project investment evaluation
independent project
Definition: The investment or abandonment of this project is not affected by the investment decisions of other projects.
When evaluating independent projects, attention should be paid to whether it is financing or investment and whether the cash flow is unconventional.
Mutually exclusive projects
Definition: Mutually exclusive items, that is, if item A is selected, item B cannot be selected again
Questions and options
scale issue
Solution: Key points: When selecting mutually exclusive projects, the IRR method cannot be used directly
(1) Compare the NPV of two projects;
(2) Calculate the NPV of the incremental project (incremental), whether it is > 0;
(3) Calculate the IRR of the incremental project and compare it with the market discount rate
Incremental project: Subtract the cash flow of the small investment project from the large investment project at time 0 to create a new investment project.
a matter of time
Solution: Key points: When selecting mutually exclusive projects, the IRR method cannot be used directly
(1) Compare the NPV of two projects; choose the project with the larger NPV value
(2) Calculate the NPV of the incremental project (incremental), whether it is > 0;
(3) Calculate the IRR of the incremental project and compare it with the market discount rate