full description of project appraisal in financial markets

1. PRESENTATION
ON
PROJECT APPRAISAL &
Its FINANCIAL TECHNIQUES

2. Project appraisal
Project appraisal is a generic term
that refers to the process of
assessing, in a structured way, the
case for proceeding with a project or
proposal. In short, project appraisal is
the effort of calculating a project's
viability. It often involves comparing
various options, using economic
appraisal or some other decision
analysis technique.

3. PROCESS OF PROJECT APPRAISAL
 Initial Assessment
 Define problem and long-list
 Consult and short-list
 Develop options
 Compare and select Project appraisal

4. Financial techniques for project
appraisal
 Net present value (NPV)
 Internal rate of return (IRR)
 Average rate of return (ARR)
 Pay back period
 Discounted payback period
 Profitability index

5. Net Present Value
(NPV)
The difference between the present value of cash inflows and the
present value of cash outflows. NPV is used in capital budgeting to
analyze the profitability of a project.
The following is the formula for calculating NPV:
where:
Ct = net cash inflow during the period
Co= initial investment
r = discount rate, and
t = number of time periods

6. Advantages Of NPV
1. NPV gives important to the time
value of money.
2. In the calculation of NPV, both after
cash flow and before cash flow over
the life span of the project are
considered.
3. Profitability and risk of the projects
are given high priority.
4. NPV helps in maximizing the firm's
value.

7. Disadvantages Of NPV
1. NPV is difficult to use.
2. NPV can not give accurate decision if the
amount of investment of mutually exclusive
projects are not equal.
3. It is difficult to calculate the appropriate
discount rate.
4. NPV may not give correct decision when
the projects are of unequal life.

8. Internal Rate of Return
The discount rate often used in capital budgeting
that makes the net present value of all cash flows
from a particular project equal to zero. Generally
speaking, the higher a project's internal rate of
return, the more desirable it is to undertake the
project. The formula for IRR is:
0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3
+ . . . +Pn/(1+IRR)n
where,
P0, P1, . . . Pn equals the cash flows in periods 1,
2, . . . n, respectively; and
IRR equals the project's internal rate of return.

9. Advantages Of IRR
1. IRR method considers the time value
of money.
2. IRR method discloses the maximum
rate of return the project can give.
3. IRR method considers and analysis
all cash flows of entire project.
4. IRR method ascertains the exact
rate of return the project earns.

10. Disadvantages Of IRR
1. IRR method is difficult to understand,
complications due to trial and error
method.
2. The important drawback of IRR is that it
recognizes the cash inflows generated
by project is reinvested to internal rate of
project, but NPV recognizes such cash
inflows are reinvested to cost of capital
of the organization.
3. Single discount rate ignores the varying
future interpret rate.

11. Average Rate Of Return (ARR)
 Average rate of return (ARR) is also known as
accounting rate of return. ARR is based upon
accounting information rather than on cash flow. In
other words, Accounting rate of return (ARR) refers to
the rate of earning or rate of net profit after tax on
investment.
ARR consider profitability rather than liquidity. Under
ARR technique, the average annual expected book
income is divided by the average book investment in
the project.
ARR = (Average net income/Average investment) x 100
Where,
Average net income= Total net income/No. of years
Average investment= Net investment/2

12. Illustration for ARR
The initial investment of the project is Rs.30,000. The net profit after
tax is as follows:
Year Net profit after tax($)
1 25000
2 30000
3 20000
4 25000
5 40000
Solution
Calculation of ARR:
ARR = (Average net income/Average investment) x 100
= (28000/15000) x 100 = 18.67%.
Where,
Average net income = Total net income/No, of years
= 25000+30000+20000+25000+40000/5 = 28000
Average Investment = Net investment/2 = 30000/2 = 15000

13. Advantages Of ARR
1. ARR is based on accounting
information, therefore, other special
reports are not required for
determining ARR.
2. ARR method is easy to calculate and
simple to understand.
3. ARR method is based on accounting
profit hence measures the
profitability of investment.

14. Disadvantages Of ARR
1. ARR ignores the time value of
money.
2. ARR method ignores the cash flow
from investment
3. ARR method does not consider
terminal value of the project.

15. Payback period Method
A company chooses the expected
number of years required to recover
an original investment. Projects will
only be selected if initial outlay can be
recovered within a predetermined
period. This method is relatively easy
since the cash flow doesn't need to be
discounted. Its major weakness is that
it ignores the cash inflows after the
payback period, and does not
consider the timing of cash flows.

16. Advantages Of Pay Back
Period
1. Pay back period is simple and easy to
understand and compute.
2. Pay back period is universally used and
easy to understand.
3. Pay back period gives more importance on
liquidity for making decision about the
investment proposals.
4. Pay back period deals with risk. The project
with a shortest PBP has less risk than with
the project with longest PBP.

17. Disadvantages Of
Pay Back Period
1. In the calculation of pay back period,
time value of money is not recognized.
2. Pay back period gives high emphasis
on liquidity and ignores profitability.
3. Only cash flow before the pay back
period is considered. Cash flow
occurred after the PBP is not
considered.

18. Discounted payback
period
The discounted payback period is the
amount of time that it takes to cover
the cost of a project, by adding the net
positive discounted cashflows arising
from the project. It should never be the
sole appraisal method used to assess
a project but is a useful performance
indicator to contextualise the project’s
anticipated performance.

19. Advantages of Discounted
Payback Period
 owners and managers like regular
payback period to know how long it will
take them to recover their initial
investment. Using discounted payback
period simply gives them a more finely
tuned estimate of that.
 discounted payback period has an
advantage over regular payback period
for that very reason - cash flows are
discounted and calculation gives a better
estimate of payback period.

20. Disadvantages of Discounted
Payback Period
 Time value of money is not considered when you
calculate payback period. In other words, no
matter in what year you receive a cash flow, it is
given the same weight as the first year. This flaw
will cause managers to overstate the time to
recovery for the initial investment.
 A second flaw is the lack of consideration of cash
flows beyond the payback period. If the capital
project lasts longer than the payback period, then
cash flows the project generates after the initial
investment is recovered are not considered at all
in the payback period calculation.

21. Profitability Index
This is the ratio of the present value of
project cash inflow to the present
value of initial cost. Projects with a
Profitability Index of greater than 1.0
are acceptable. The major
disadvantage in this method is that it
requires cost of capital to calculate
and it cannot be used when there are
unequal cash flows. The advantage of
this method is that it considers all cash
flows of the project.

22. Advantages Of Profitability
Index
1.Profitability index considers the time
value of money.
2. Profitability index considers analysis
all cash flows of entire life.
3. Profitability index makes the right in
the case of different amount of cash
outlay of different project.
4. Profitability index ascertains the
exact rate of return of the project.

23. Disadvantages Of Profitability
Index
1. It is difficult to understand interest
rate or discount rate.
2. It is difficult to calculate profitability
index if two projects having different
useful life.