The aim of investing is to obtain income from capital. Each investor is primarily interested in investing, in which every unit of currency will bring maximum profits. The special criterion -profitability index-is used for the calculation of such data.
Evaluation of projects
The principle of efficiency determination is in comparing of the analyzed indicator with the base value. The following indicators are used for evaluation of projects:
NPV
This indicator is calculated as the difference between the investment and the current value of payments. NPV eliminates the time factor. If the net present value is > 0- the project is profitable; it is equal to 0, a volume increase will not boost profits; if it is < 0 the project is unprofitable.
NPV is an absolute indicator. Its value is strongly influenced by the original investment amount and allocation of costs` structure. The more costs in subsequent periods are, the greater the sum of the net provided income will be. Therefore, the high value of this indicator does not always mean more effective investment.
IRR
This coefficient characterizes the maximum cost of the investment (expenditure), which may be incurred in the framework of the project. If funding is obtained by means of bank loans, the value of IRR indicates the upper bound of the services` rate. In case of its exceeding, the project will be unprofitable. Economic sense: the company can make decisions, the profitability of which exceeds the current cost-CC: if the profitability rate is > !!- the project is profitable; if the profitability rate is < CC- the project is unprofitable, it should be rejected; if the profitability rate is = CC- the project is lossless, but it will not bring profit.
PI
The indicator "profitability index" is relative. It displays net cash flow- to-costs ratio. Due to this advantage, the indicator can be used for comparative assessment of different projects identifiable by the volume of initial investment. The profitability index should also be used to identify and exclude inefficient projects still pending.
Projects with a higher profitability index are more steady. However, do not forget that the great values of the coefficient do not always correspond to the level of net present value and vice versa.
ROC
ROC shows how the price is changed now compared to the period “N” in the past. It can be presented in points or as a percentage.
PP
The period during which the funds in an amount to compensate the initial investment will arrive, is called payback period. It is measured in months and years. As soon as the payback period comes, NPV becomes positive.
The decision about investing in the project is taken based on the above-mentioned indicators.
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