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A Note On The Financial Evaluation Of Projects

            

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APPRAISAL TECHNIQUES IN PRACTICE FOR VARIOUS TYPES OF PROJECTS

•The most commonly used method for conducting a financial appraisal of small projects requiring less financial investments is the payback method.
•For larger projects, the average rate of return is commonly used as the principal criterion and the payback period is used as a supplementary criterion.
•Discounted cash flow (DCF) techniques are now being increasingly used to evaluate large investments.
•Many other criterias are used for evaluating investments: profit per rupee invested (calculates the actual profit earned in terms of each rupee invested); cost saving per unit of product (calculates the amount of savings on the cost of production per unit); and investment required to replace a worker (calculates the additional amount required to replace an existing worker).

CAVEATS FOR IMPROVED FINANCIAL EVALUATION

•The appraisal criteria for evaluating projects should be standardized. The use of many methods makes comparison between projects difficult.
•The approach followed for evaluating projects must be clearly defined. Vague qualitative phrases should be substituted by quantitative measures wherever possible. This is necessary to promote understanding and avoid confusion.
•Discounted cash flow techniques should receive greater emphasis. They are theoretically superior and practically feasible.
•To sum up, the evaluation must be carried out in explicit, well-defined, preferably standardized terms and should be based on sound economic principles. Investment decision-making must be based on a careful and sound evaluation of the available data.

CONCLUSION

The selection of a technique essentially depends on whether the projects are independent or mutually exclusive and whether or not capital rationing is applied to them. Firms generally use the discounted cash flow method as the primary evaluation technique and conventional methods as secondary techniques for evaluating a single project. Project evaluation techniques help a firm maximize wealth by determining the right project to be undertaken from the various alternatives available to the firm. The finance managers of a firm are responsible for choosing a project evaluation technique that would best suit the organization's requirements.

EXHIBIT I ASPECTS OF PROJECT APPRAISAL

EXHIBIT II PROJECT EVALUATION TECHNIQUES

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