Submitted by:

Harjot Kaur
MBA(IB)
16421307
FINANCIAL EVALUATION
 Financial evaluation has been employed
to determine whether to accept or reject
the project. The choices are made
based on various financial evaluation
methods.
 It tells whether the project will contribute
to your company overall goals or be a
drain on your resources.
VARIOUS METHODS FINANCIAL
EVALUATION
 Payback Period Method: It is defined
as length of time required to recover the
original investment on the project,
through cash flows earned. The cash
inflows includes operating profit, less
income tax payable, plus deprecation.
 Formula: Total investment
cash inflows
Example
 Payback period of the project B is shorter
than A, but A provides higher return. Hence
project A is superior B.
PROJECT A PROJECT B
50,000 1,00,000
50,000 5,000
1,10,000 5,000
NONE NONE
TOTAL
2,10,000 1,10,000
PAYBACK
2 YEARS 1 YEAR
AVERAGE RATE OF RETURN
 Average Rate of Return : The average
rate of return is also called accounting
rate of return.
 Formula: Profit after Tax
Book value of investment
If Average Rate of Return is equal to or
greater than the required accounting
rate of return. In case of mutually
exclusive projects, accept the one with
highest ARR.
Example
 XYZ company is looking to invest in new machinery
which cost for which cost 4,20,000
 Increase annual revenue by 2,00,000
 Annual expenses by 50,000
 Estimated to have useful life 12 yrs.

Calculation
 Calculate the depreciation expense per year:
420,000 / 12 = 35,000
 Calculate the average annual profit: 200,000 –
(50,000 + 35,000) = 115,000
 Use the formula: ARR = 115,000 / 420,000 = 27.4%
NET PRESENT VALUE METHOD
 Net Present Value Method : This method is one of
the discounted cash flow techniques and it
recognizes the time value of money.
 NPV = 0, it indicates that the present cash outflow
and the present value of future cash inflows are
equal and the project is acceptable.
 NPV < 1, it indicates that the present value of future
cash inflows is less than the present cash out flow
and project is not acceptable.
 NPV > 1, it indicates that the present value of future
cash inflows is more than the present cash out flow
and project is acceptable.
 Formula cash inflows – cash outflows from
investment
Example
 Cost to purchase Company ABC today: 1,000,000
 Present value (PV) of cash flows from acquiring Company ABC:
 Year 1: 200,000
 Year 2: 150,000
 Year 3: 100,000
 Year 4: 75,000
 Year 5: 70,000
 Year 6: 55,000
 Year 7: 50,000
 Year 8: 45,000
 Year 9: 30,000
 Year 10: 10,000
 Total: 7,85,000
 Now that we know the total cash flow for the next 10 years (the total cash inflows from
the investment), along with total cost of the investment in Company ABC, we can use
the formula to calculate NPV:
 Net Present Value (NPV) = 785,000 - 1,000,000 = -2,15,000
 Management for Company XYZ would use the net present value rule to decide whether
or not to pursue the acquisition of Company ABC. Because the NPV is negative, they
should say, "No."
INTERNAL RATE OF RETURN
METHOD
 Internal Rate of Return Method: It
analyses an investment project by
comparing the internal rate of return to
the minimum required rate of return of
the company.
 The minimum required rate of return is
set by management. Most of the time, it
is cost of capital of the company.
 Formula: Net initial investment
Annual cash inflows