A Note On The Financial Evaluation Of Projects

NET PRESENT VALUE Contd..

The MIRR method is superior to the IRR method. MIRR assumes that the project cash flows are reinvested at the cost of capital whereas the regular IRR assumes that the project cash flows are reinvested at the project's own IRR. Since reinvestment at the cost of capital (or some other explicit rate) is more realistic than reinvestment at IRR, MIRR reflects the true profitability of a project. In addition, the problem of multiple rates does not exist with MIRR. However, for choosing among mutually exclusive projects of different size, the NPV method is better than the MIRR method because it measures the contribution of each project to the value of the firm.

The evaluation criteria under the MIRR method are: •The project is accepted when the MIRR is greater than the cost of capital or the required rate of return. •The project is rejected when the MIRR is less than the cost of capital or the required rate of return. •The project reaches the point of indifference when the MIRR is equal to the cost of capital or the required rate of return. •When there are mutually exclusive projects, the one with the highest MIRR must be selected.

TRADITIONAL OR NON-DISCOUNTED CRITERIA

When evaluating a project's viability, traditional or non-discounted criteria generally use accounting profits rather than cash flows.

AVERAGE RATE OF RETURN METHOD

This method is also known as the accounting rate of return as it considers the accounting profits of a firm over a period of time. ARR is represented as follows: ARR = average annual income x 100/average investment throughout the life of the project

Two machines, P and Q, with an estimated salvage value of Rs 2500 have an initial cost of Rs 36500 and an estimated life of 5 years. Depreciation is charged on the basis of the straight line method. The estimated income of the machines over a period of 5 years is given in the table below. The average rate of return of the machines is calculated as follows:

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APPRAISAL TECHNIQUES IN PRACTICE FOR VARIOUS TYPES OF PROJECTS

CONCLUSION

EXHIBIT I ASPECTS OF PROJECT APPRAISAL

EXHIBIT II PROJECT EVALUATION TECHNIQUES

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