The document discusses various methods for evaluating financial projects, including net benefit analysis, present value analysis, net present value analysis, payback analysis, break-even analysis, and cash flow analysis. It provides examples and explanations of how to calculate and interpret each method. Present value analysis accounts for the time value of money by discounting future cash flows back to their present value. Net present value compares the present value of discounted cash inflows to the present value of cash outflows. Cash flow analysis tracks revenues and expenses over time to determine break-even point and payback period.
The document discusses various methods for evaluating financial projects, including net benefit analysis, present value analysis, net present value analysis, payback analysis, break-even analysis, and cash flow analysis. It provides examples and explanations of how to calculate and interpret each method. Present value analysis accounts for the time value of money by discounting future cash flows back to their present value. Net present value compares the present value of discounted cash inflows to the present value of cash outflows. Cash flow analysis tracks revenues and expenses over time to determine break-even point and payback period.
Copyright:
Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online from Scribd
The document discusses various methods for evaluating financial projects, including net benefit analysis, present value analysis, net present value analysis, payback analysis, break-even analysis, and cash flow analysis. It provides examples and explanations of how to calculate and interpret each method. Present value analysis accounts for the time value of money by discounting future cash flows back to their present value. Net present value compares the present value of discounted cash inflows to the present value of cash outflows. Cash flow analysis tracks revenues and expenses over time to determine break-even point and payback period.
Copyright:
Attribution Non-Commercial (BY-NC)
Available Formats
Download as PPT, PDF, TXT or read online from Scribd
and broken down into cost categories, the analyst must select a method of evaluation. The most common methods are: Net Benefit Analysis Present Value Analysis Net Present Value Pay Back Analysis Break-even Analysis Cash-flow Analysis Net Benefit Analysis This method involves subtracting total costs from total benefits. Advantage: It is easy to calculate, easy to interpret and easy to present. Drawback:It does not account for time value of money and does not discount for future cash flow. Money has a time value.The time lag accounts for time value of the money. The time value of money is extremely important in evaluation process. Net Benefit Analysis-an example
Cost/Benefit Year 0 Year 1 Year2 Total
Costs -1000 -2000 -2000 -5000
Benefits 0 650 4900 5550
Net Benefits -1000 -1350 -2900 550
Present Value Analysis In developing long-term projects, it is difficult to compare today’s cost with the full value of tomorrow’s benefits. The time value for money allows for interest rates, inflation and other factors. Present value analysis controls these problems by calculating the cost and benefits of the system in terms of today’s value of investment. The investment has to be made today, whereas the benefits are in the future. The amount we are willing to invest today is determined by the value of benefits at the end of given period. The amount is called present value of the benefit. Present value formula is: P=F/(1+I)n where P=Present value F=Future value I= Interest rate n=No. of years Present Value Analysis-an example Suppose Rs. 3000 is to be invested in a system and the average annual benefit is Rs. 1500 for the 4 year life of the system. So the present value of Rs. 1500 at 10% interest at the end of 4th year is: P=1500/(1+0.10)4 = 1500/1.61 =Rs. 1027.39 If we invest Rs. 1027.39 today at 10% interest, we can expect to have Rs. 1500 in four years. Present value Analysis using 10% interest rate Estimated Discount Present Cumulative Year Future value rate Value Present value of benefits
1 Rs. 1500 x 0.908 = Rs. 1363 Rs. 1363
2 1500 x 0.826 = 1239 2602 3 1500 x 0.751 = 1127 3729 4 1500 x 0.683 = 1027 4756
Discount Rate= 1/(1+I)n
Net Present Value The net present value is equal to discounted benefits minus discounted costs. The net present value is expressed as a percentage of investment. The formula is: Net present value(in %)= net present gain/investment In our example, Net present value=1756/3000=0.55% Pay Back Analysis It determines the time it takes for the accumulated benefits to be equal to the initial investment. The shorter the pay-back period, the sooner a profit is realized and more attractive is the investment. The payback period can be calculated by the following formula: Payback period= Overall cost/Annual cash returns The payback method is easy to calculate and allows two or more activities to be ranked. Break-even Analysis Break-even is the point where the cost of the candidate system is equal to the cost of current system. When a candidate system is developed, initial costs usually exceed those of the current system. This is an investment period. When both costs are equal, it is break-even. Beyond that point, the candidate system provide better benefits. This is called return period. Break-even analysis is used to compare costs of using present and candidate system. Cash Flow Analysis
Cash flow analysis keep track of the
accumulated costs and revenue on a regular basis.Here Cash Flow=Revenues-expenses Advantage: It combines the benefits of payback and break-even analysis. Cash Flow Analysis-An example
Here, break-even occurs in May month. The cash flow was
Rs. 900,although the accumulated cash flow was –6100. Accumulated Cash flow begins to become +ve in Aug, this is the beginning of the pay back period. Summary
CBA is a tool for evaluating projects rather
than a replacement of the decision maker. In real-life business situations, whenever a choice among alternatives is considered, CBA is an important tool. However, it has some problems: Valuation problem:Intangible costs and benefits are difficult to quantify and tangible costs are more pronounced than tangible benefits. Distortion Problem:There are 2 ways of distorting the results of CBA. Intentional favoritism of an alternative for political reasons. When data are incomplete or missing from the analysis. Completeness Problem: Occasionally, an alternative is overlooked that compromises the quality of the final choice. The cost may be on higher side or not enough costs may be considered to do a complete analysis. In either case, the reliability of final choice is in doubt.