Project Appraisal – Time Value of Money

Compounding Discounting- Discounted

and Undiscounted Measures
 Content of Lecture

• What is Project Appraisal?

• Methods of Project Appraisal

• Financial and Economic Appraisal of the Project

• Time Element in Financial Appraisal

• Method of Financial Appraisal

 Project Appraisal Definition

Project Appraisal
It is a consistent process of reviewing a project and
evaluating its content to approve or reject this project,
through analyzing the problem or need to be addressed by
the project, generating solution options (alternatives) for
solving the problem
 Methods of Project Appraisal

• Economic Appraisal
• Financial Appraisal

• Commercial and Market Appraisal

• Technical Appraisal
• Legal appraisal
 Financial and Economic Appraisal of
the Project

 Financial Appraisal is important for understanding whether a

project is financially viable

 Economic Appraisal is financially sustainable and capable

of bring the project to execution
 Time Element in Financial Appraisal

Compounding finds a future value of a present payment, or value,

that is compounded annually for a specified number of years. The
basic formula for compounding is:
• Fvn = PV (1+ i)n
PV = the present value, i = discount rate,
Fvn = a future value, in year n,
n = the number of years until a future value occurs

Discounting adjusts a future value to the present time. The

“adjusted” value is the present value and can be calculated using
the following
PVn = FV /(1+ i)n
 Method of Financial Appraisal
It is also called as Capital Budgeting
Methods
Discounted Measures
 Net Present Worth
 Benefit Cost Ratio
 Internal Rate of Return

Undiscounted Measures
 Ranking by inspection
 Pay Back Period
 Proceeds per unit outlay
 Average annual proceeds per unit outlay method
Net Present Worth 

• The net present value of a project is equal to the sum of the present value of

all the cash flows associated with the project.

• One of the most important concepts originating from the time value of

money, NPV is calculated by subtracting the present value of the cash

outflows (investment) from the present value of the cash inflows (income)
The formula for calculating the NPV is:                                               
• where           NPV    =        net present value
                      CFt      =        cash flow occurring at the end of year
                       C0       =        Initial cash outflow or investment
                         t        =        (t = 0 ......n), A cash inflow has a  positive sign,
                                                whereas a cash outflow has a negative sign
•                      n        =        life of the project
•                       k        =        cost of capital used as the discount rate
Features of Net Present Value 
• The NPV method is based on the assumption that the
intermediate cash inflow of the project is reinvested at a rate
of return equal to the firm's cost of capital.

• The NPV of a simple project monotonically decreases as the

discount rate increases; the decrease in NPV, however, is at a
decreasing rate
• NPV the acceptance rule is
               NPV > 0  Accept
              NPV = 0  Indifferent
              NPV < 0  Reject
 Benefit Cost Ratio (BCR)

• The Benefit Cost Ratio is worked out by dividing the present

value of cash inflows by the present value of cash outflows.

• If the BCR is more than one, that project is accepted and if BCR is
less than one the project is rejected.

• Among the different projects, the project with highest BCR is to

be selected.
 Internal Rate of Return

 It is the rate of return per rupee invested in an agricultural project over

its life span.

 It is the rate of return at which the present value of total cash flows in a
project over its life span.

 Marginal efficiency of Capital of the Project

Decision of IRR
IRR > More than bank interest rate – Project accepted
IRR < More than bank interest rate – Project rejected
THANKS FOR ALL