Planning and

Evaluation of
Agricultural Project

(324 AEC)
 Chapter (2)


Feasibility Study of
Financial Projects
 Undiscounted measures
Undiscounted measures:
Include the following:
1- Payback Period
4- Average annual proceeds per unit of out
lay
2- Break-Even Analysis
3- Simple Rate of Return
 1-Payback Period:
 The payback period is the number of
years it would take an investment to
return its original cost.
 Or the payback period for a project is
the length of time from the beginning
of the project until the net returns
equals the value of the initial
investment
 . If you have the net cash
revenues are constant each
year.
 Payback Period=capital
investmentannual/ net cash
flow of project
P =C / E
Where C is original cost and E is the
expected annual net cash revenue
 Example1:
 Net Cash Revenues for Two
$10,000 Investments as the
following Finding Payback
Period:
 Finding Payback Period:
Year Investment Investment
A B
1 3000 1000

2 3000 2000

3 3000 3000

4 3000 4000

5 3000 6000
 Total cash 15000 16000
revenues

Less initial -10000 -10000

investment
Net Cash 5000 6000
Revenues
Average net 1000 1200
revenue/year
 The payback period for investment
A is 3.33 years ($10,000 ÷ 3000)
 The payback for investment B is 4
years, which is found by summing
the revenues until they reach
$10,000.
 Example2:
 If you invest $10,000 today and are
promised $5,000 one year from today and
$5,000 two years from today,
solution
 the payback period is two years, it
takes two years to get your $10,000
investment back.
 Example3:
 Suppose you are considering Investments
A in the following table, it requires an
investment of $1,000,000 today. How
long does it take to your $1,000,000
investment back?
 The payback period for Investment
A is four years:
 Investment A

year Value at the Accumulated

End of 2000 Cash Flow
1 $363,640 $363,640
2 330,580 694,220
3 300,530 994,750
4 273,205 1,267,955 $1,000,0
5 248,369 1,516,324 00
investme
nt paid
back
 By the end of the second year, the
full $1 million is not paid back, but
by the fourth year, the
accumulated cash flow exceeds $1
million. Therefore, the payback
period for Investment A is four
years.
 Example 4:
Project Payback arrangement
period
A 2 1

B 2 1

C 2.8 4

D 2.7 3
 Limitations of the Payback Period
 The payback period is easy to calculate and
identifies the investments with the most
immediate cash returns. But it ignores
returns after the end of the payback period
as well as the timing of cash flows because a
shorter payback period is better than a
longer payback period. Yet there is no
clear-cut rule for how short is better.
 2- Break-Even Analysis
Process Selection with Break-Even Analysis
 Total cost= total fixed cost + total variable cost
 TC = FC+ VC
 Total revenue = volume x price
 TR = V P
 Profit = total revenue - total cost
 Π = TR - TC
 = VP - (FC+ VC)
 Solving for Break-Even Volume
 TR= TC
 VP = FC+ VC
 VP - AVC = FC
 V (P - AVC) = FC
 V =FC / (P – AVC)
Where:
 FC = fixed cost
 VC = variable cost
 V = volume (i.e., number of units produced and
sold)
 AVC = variable cost per unit or Average
variable cost
 P = price per unit
 Example 1:
 If you have Fixed cost = FC = $2,000
 Variable cost =AVC= $5 per unit
 Price = P = $10 per unit
Solution
The break-even point is
V =200/(10-5) = 400 units
 If the firm produces and sells 400 units,
there is no operating profit.
 If the firm sells 400 units, profits to
owners will be zero. If the firm sells
less than the 400 units, the firm has a
loss and if the firm sells more than the
400 units, the firm has a profit
 If the firm produces and sells 400 units,
there is no operating profit.
 If the firm sells 400 units, profits to
owners will be zero. If the firm sells
less than the 400 units, the firm has a
loss and if the firm sells more than the
400 units, the firm has a profit
 Choosing Between Two Processes
 Process A Process B
 $2,000 + $5V = $10,000 + $2V
 $3v = $8,000
 V = 2,667 units
 Below 2,667, choose A

 Above 2,667, choose B

 Point of Indifference
 Volume where cost of A = cost of B
 Rule for choosing process:

 Above point of indifference choose

process with lowest variable cost
 Below point of indifference choose
process with lowest fixed cost
3- Simple Rate of Return: (proceeds
per unit of outlay):
 Simple Rate of return =average annual
net revenue / initial cost *100
 Simple Rate of return =net average
cash flow / invested capital *100
 In this case the Simple Rate of Return
must be more than the other
opportunity for investment
 Profit Margin =Net profit / net value of sold
products
Profit Margin reflects the productivity of sold
products; it represents the profit % in the
project. As the profit increases, the return
on investment increases and this cause more
benefits for the project.
Simple Rate of return =Net profit / invested
capital
 Capital rotation = net value of sold
products / invested capital
 Capital rotation=return on
investment / Profit Margin
 Simple Rate of Return =Capital
rotation× Margin Profit
Calculate the Simple Rate of Return
for E.x.1
 Simple Rate of return Investment A =
1000 / 10000 *100 = 10%
 Simple Rate of return Investment B =
1200 / 10000 *100 = 12%
Disadvantages of Simple Rate of
Return:
 (1) dose not take care of cash flows
in costs from one year to another
where time doesn't take into
consideration in evaluation, where
it gives the unit of the present
money the same value of money in
the future.
 (2) It is supposed that the invested
capital is constant but actually it is
value is decreased according to
consumption or constant invested
capital in the project's production life
time.
 (3) Can't be used when there is high
risk in investing.
 Example2:
 If a project is expected to achieve annually
profits about 800,000 pounds, invested
capital =4,000,000 pounds.
 Calculate the Simple Rate of
Return
 Solution
 Simple Rate of return =Net profit /
invested capital *100
 Simple Rate of return =800 / 4000
*100=12%
4- Average annual proceeds per unit
of out lay:
 Average annual proceeds per unit of
out lay is the total net value of
incremental production for the project
divided by the number of years of
production and then the result is
divided by capital investment of the
project.
 Disadvantages of average return:
 1) The time period of return
doesn't take into consideration.
 2) Doesn't consider the time
difference costs of money.
 3) It prefers projects with short life
time that have high cost returns
 Example:
 Suppose we have 3 different projects
presented to the project's managers,
the invested cost required for each of
them is 100,000 pounds, supposing that
these 3 projects make annually cash
flows as in the following table:
 Choose between these 3 projects by using
the formula of average return.
Year 1st project 2nd project 3rd project
1 80 20 20

2 60 40 60
3 40 60 60
4 20 80 40
5 50 0 40
6 0 0 40
7 0 0 20
Total 250 200 280
 Solution

 Average of cash flows of 1st project =

250 ÷ 5= 50, 000 pounds
 Average of cash flows of 2nd project =
200 ÷ 4 = 50, 000 pounds
 Average cash flow of 3rd project = 280
÷ 7 = 40,000 pounds.
 So, we can calculate average rate of
return for every project as follows:
 For 1st project = 50 ÷100 × 100= 50%
 For 2nd project = 50÷100 × 100 = 50%
 For 3rd project = 40 ÷100 × 100 = 40%
 According to this project (1&2) are equal in
terms of best projects, followed by the 3rd
project.
 Although the 3rd project gives bigger total
return for longer production life time, but it
is the last best project among the three
projects, for this its economic life time
increases.
Thank You