InvestorQ : What strategies to be applied for evaluating investment proposals?
divya Sing made post

What strategies to be applied for evaluating investment proposals?

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vani Patil answered.
3 weeks ago

There are several methods that can be used to screen investment proposals. I am listing some of the common ones below-

First Year’s performance method: According to this method, the investment projects are evaluated on the basis of their impact on revenues and expenses in the first year. If the increased revenue from added sales, or the savings in the expenses relating from the improved technique or equipment, exceed all the added expenses including interest and depreciation, the investment is accepted, otherwise it is rejected.

Degree of urgency method: Here the projects are ranked according to their subjective importance. Some projects are needed at once while some others may be postponed to the future. Those projects that cannot be postponed and are needed on an urgent basis are undertaken first. For example, if there is a breakdown in the production process due to the loss of any component, the management takes a decision at once to buy the available one to avoid the delay.

Payback Period Method:   This method is based on the principle that every capital expenditure pays itself back over a number of years. It means that it generates income within a certain period. When the total earnings (or net cash-inflow) from investment equals the total outlay, that period is the payback period of the capital investment. An investment project is adopted so long as it pays for itself within a specified period of time say 5 years or less. This standard of recoupment period is settled by the management taking into account a number of considerations. While there is a comparison between two or more projects, the lesser the number of payback years, the project will be acceptable.

Accounting Rate of Return Method: This is also known as the financial statement method or Un-adjusted rate of return method. According to this method, capital projects are ranked in order of earnings. Projects which yield the highest earnings are selected and others are ruled out. The accounting rate of return method is subdivided into many others like ARR or average rate of return method, earning per unit, average investment, etc.

Discount Cash-flows Techniques: This method involves calculating the present value of the cash benefits discounted at a rate equal to the firm’s cost of capital. In other words, the present value of an investment is the maximum amount a firm could pay for the opportunity of making the investment without being financially worse off. Discount Cash-flows Techniques are divided into many others, like IRR, NPV, terminal value method, etc.

Internal rate of return method: Like discounted cash flow, the internal rate of return (IRR) method also takes into account the time value of money. It analyzes an investment project by comparing the internal rate of return to the minimum required rate of return of the company. The internal rate of a return sometimes known as the yield on the project is the rate at which an investment project promises to generate a return during its useful life. It is the discount rate at which the present value of a project’s net cash inflows becomes equal to the present value of its net cash outflows. In other words, the internal rate of return is the discount rate at which a project’s net present value becomes equal to zero.

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amar diwakar answered.
3 weeks ago

Urgency method
Pay back period method
Net present value method