There are several ways to assess the attractiveness of investment projects, and there are several important performance indicators. Each method is based on the same principle: as a result of the project, the company should make a profit (increase in corporate capital), as well as various financial indicators, characterize the project from different sides, and can meet the interests of different groups of persons related to the company - the interests of creditors, investors, managers.
The following key indicators are used to assess the efficiency of investment projects.
- The payback period of the investment is PP (Payback Period);
- Net present value is NPV (Net Present Value);
- Internal rate of return -IRR (Internal Rate of Return);
- Modified internal rate of return -MIRR (Modified Internal Rate of Return);
- Return on investment - P (Profitability);
- Profitability Index - PI (Profitability Index);
Each indicator is a criterion for decision-making when selecting the most attractive project out of several possible projects.
The calculation of these indicators is based on the discount method, which takes into account the principle of time value of money. In most cases, the WACC weighted average cost of capital, which, if necessary, can be adjusted for possible risk indicators, is related to the implementation of certain projects and the expected rate of inflation.
If the calculation of the WACC indicator is associated with a difficulty in asking questions about the reliability of the results (e.g., estimating equity), the average market return adjusted for the risk of the project under analysis should be chosen as the discount rate. Sometimes the refinancing rate is used as the discount rate.
The main steps in assessing the effectiveness of an investment:
- assessment of corporate financial capacity.
- Prediction of future cash flows.
- Choice of discount rate.
- Calculation of key performance indicators.
- Consideration of risk factors
Assessment of investment projects of different duration
If there are doubts about the accuracy of the comparison using the projected project indicators at different times of implementation, a chain repetition method can be relied upon.
Using this method, we find the smallest total multiple of n times the time n1 and n2 of the project being evaluated. A new cash flow is created as a result of several project implementations, assuming that costs and income remain at the same level (the next implementation starts as soon as the previous one is completed). Although net present value will change as iteration progresses, the internal rate of return will remain the same regardless of the number of iterations, but if the initial investment is greater than the income by the end of the implementation period, the new cash flow may become non-standard.
In fact, the use of this method may involve complex calculations, if several projects are taken into account, and in order to coincide with all the deadlines, each one must be repeated several times.
The main disadvantage of the chain repetition method is that in the current market situation it is almost impossible to keep the conditions of project implementation and, consequently, the necessary costs and revenues at the same level. In addition, reimplementation of the project itself is not always possible, especially when it is long enough or when it is in an area where rapid technical updates of the product take place.
In addition to a quantitative indicator of investment efficiency, it is necessary to take into account the qualitative characteristics of the attractiveness of projects that meet the following criteria when making investment decisions
Prospects in comparison with the results of refusing to implement alternative projects
- Compliance of the considered project with the general investment strategy of the enterprise, its long-term and current plans;
- Compliance with normative and planned indicators of project risk level, financial stability, economic growth, etc;
Ensuring the necessary diversification of financial and economic activities of the organization.
Compliance with project implementation requirements using available production and human resources.
Influence of the project implementation on the society, influence on the reputation and image of the enterprise.