A Note On The Financial Evaluation Of Projects
 INTRODUCTIONThe project evaluation process
involves more than just determining a project's expected revenues and
profitability; it also involves a study of the key factors that affect a
project and their financial impact on the project. In addition, a project
evaluation includes strategic evaluation, economic evaluation and social
impact evaluation (Refer Exhibit I).
While the financial evaluation of a project aims at ascertaining the most
efficient strategy for delivering the desired output, the strategic
evaluation ensures that the project is consistent with the output objectives
of the firm. The economic evaluation of the project, however, seeks to
ensure that the delivered output is benefiting the public at large. The
evaluation of social impact aims at ensuring that the consequences of a
project (in terms of employment, output, savings and so on) are beneficial
to the public. The financial appraisal is the most important part of the
evaluation because the project cannot be successful if it is financially
unviable, even though it may be technically and commercially feasible.
DEFINING THE TERMSProjects, by their definition, have a defined start and end date. A project is defined as “a collection of linked activities, carried out in an organized manner with a clearly defined start point and finish point, to achieve some specific results that satisfy the needs of an organization as derived from the current business plans.”[1]
Projects are characterized by pre-determined goals, defined scope,
limited resources, sequenced activities and a specific end result. While
discussing the evaluation of a project, it is important to understand
some other terms that are often used. |
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Cost of capital refers to the rate of return which must be
earned by a firm in order to satisfy the expectations of the investors who
provide the funds for the firm.
It is measured as the weighted arithmetic average of the
cost of various sources of finance obtained by the firm. Expected return is
the arithmetic mean or average of all possible outcomes where those outcomes
are weighted by the probability of their occurrence. The legal, printing,
postage, underwriting brokerage costs, and other costs of issuing
securities, are known as floatation costs. Incremental cash flow is the
difference in cash flows of a firm with and without a project. It can also
be defined as the change in the future cash flows of a firm as a direct
consequence of undertaking a project. The value of a future stream of
payments or receipts from a project when discounted at a given rate to the
present time it is known as the present value of a project. Projects are
said to be mutually exclusive when the acceptance of one will necessarily
mean the rejection of others.
The net present value of a project is the present value of future payments
reduced by the present value of costs. The rate of discount at which the net
present value of an investment is zero is called the internal rate of
return. Benefit cost ratio measures the present value of returns per rupee
of investment. Sensitivity analysis is a risk analysis technique used for
studying the responsiveness of net present value to changing a variable in
the profitability equation. It is akin to ‘what if'analysis. For example,
we can know the impact of reduction in the costs of raw materials by 10 % on
NPV of a project.
FINANCIAL EVALUATION
CASH FLOWS FROM LONG TERM FUNDS POINT OF VIEW
CASH FLOWS FROM EQUITY FUNDS POINT OF VIEW
CASH FLOWS FROM TOTAL FUNDS POINT OF VIEW
CHOICE OF DISCOUNT RATE
APPRAISAL CRITERIA
DISCOUNTED CASH FLOW/TIME ADJUSTED TECHNIQUES
NET PRESENT VALUE
APPRAISAL TECHNIQUES IN PRACTICE FOR VARIOUS TYPES OF PROJECTS
CONCLUSION
EXHIBIT I ASPECTS OF PROJECT APPRAISAL
EXHIBIT II PROJECT EVALUATION TECHNIQUES
[1] Young L. Trevor, “The Handbook of Project
Management,” Pg. No. 16.
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