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E3.2 - Financial Models
E3.2 - Financial Models
MBA 430
Selecting
SelectingProjects:
Projects:
Using
UsingFinancial
FinancialModels
Models
Project Goals
Selection Criteria
• IRR
IRR •
• NPV
Financial
FinancialModels
Models
NPV
• ROI
ROI
•
•
• Payback
Payback •
Application to Scenario
Ranking & Selection
Conclusion
Conclusion
Project Classification
Project Classification
Strate
Strate
gic
gic
Align
Strategy is Every project
Align
ment
implemented should have
ment
through clear link to
projects strategy
Portfolio Management
Portfolio Management
Project Management
Project Management
• Selection criteria need to ensure that each project is prioritized and
contributes to strategic goals however some organizations fail to do this.
Non-financial Models
Non-financial Models
Checklist Model
Checklist Model
Multi-Weighted Scoring Model
Multi-Weighted Scoring Model
Financial Models
Financial Models
Payback Period
Payback Period
Return on Investment (ROI)
Return on Investment (ROI)
Net Present Value (NPV)
Net Present Value (NPV)
Internal Rate of Return (IRR)
Internal Rate of Return (IRR)
Payback Model
Payback Model
Payback model measures the time taken to recover the project investment.
NPV model is based on time value of money and uses RRR to discount all
the future net cash flows for a project to a present value.
Projects with positive NPV is eligible for further consideration.
Where:
n CCt
∑∑ n C = net cash flow
NPV tt
-------------------- t = time period
NPV (1 + r) --------------------
t n = number of periods
t = 0 (1 + r) r = required rate of return
t=0
• Advantages:
1. Considers the time value of money (cash).
2. Emphasizes cash flow throughout the project.
3. Uses multiple RRR when considering projects with different risks.
• Limitations:
1. Comparison between projects ignores initial investment value.
2. Does not provide a percentage return on total investment.
Internal Rate of Return (IRR) Model
Internal Rate of Return (IRR) Model
NPV
$
IRR (NPV = 0)
0 Discount Rate
%
n CCt
IRR NPV 0
0 ∑∑
t=0
n
(1 + r)
tt
--------------------
--------------------
(1 + r)
t
t=0
• Advantages:
1. Provides a percentage return on total investment.
2. Can be easily compared to benchmarks for selection.
• Limitations:
1. Comparison between projects ignores initial investment value.
2. Complex to calculate manually and can be done by trail & error.
Application to Scenario
Application to Scenario
Strategic Project A - Developing Real Estate
Strategic Project A - Developing Real Estate
• Initial investment of $350,000.
• • Initial investment of $350,000.
Projected cash inflow :
•$200,000
Projected
in cash inflow
the 2nd :
year.
$200,000ininthe
$300,000 the3rd
2ndyear.
year.
$300,000
$150,000 in the
in the 4th 3rd year.
year.
$150,000 in the 4th year.
For each of the project the average cash inflow was worked out for the
entire project life.
This was then divided with the initial investment to find ROI.
IRR was calculated using excel. NPV was set at zero and the discount rate
which is the IRR was found.
The following shows how the value are used in the formula:
Apartment
IRR:
NPV = 0 = -$350,000/(1+r)0 + $150,000/(1+r)1 + $250,000/(1+r)2
+ $100,000/(1+r)3
The value of r (IRR) was then calculated.
Pass
Select (Priority)
Conclusion
Conclusion