INVESTMENT

CRITERIA
Syeda Sultana Parveen
Professor Social Work
Shahjalal University of Science and Technology.
FINANCIAL
ARRANGEMENTS:

 Capital cost:
 Working capital:
 Operating Cost:
 Source of financing:
 Financial structure:
 Financial Institutions:
 Foreign Financial Institutions:
FINANCIAL
ARRANGEMENTS
Capital cost:
The amount of money incurred in the preparation stage
before starting the commercial function.

Working capital:
The amount required to keep the project working, running.

Operating cost::To operate the functions.

Source of financing: Two types of source.
1.Internal 2.External.
National Financial Institutions. Any Industrial Development
Bank. State Industrial Development Corporation.
FOREIGN FINANCIAL
INSTITUTIONS:

 World Bank.
• International Development Association(IDA).
 United Nations Development. Program.(UNDP).
 International Monitory Fund.(IMF).
 Asian Development Bank(ADB).

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INVESTMENT CRITERIA

 The amount of investment and the return back

needs to be determined at the analysis stage.

 The strategies normally use to know the economic

power of the project. It has two parts.

 a. Time of pay ( investment ) back.

 b. Return on investment.
INVESTMENT CRITERIA

How to take investment decision?

a. What is the goal of the project?

b. What should be correct decision

criterion?

c. What return back would be the best?

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INVESTMENT CRITERIA

 Time of money ( investment) back.

 The investment of any project needs a

specific time to return back. In another
words it is the total required year to return
back the investment.

 That project is more acceptable which will

back the investment with shortest possible
time.
TWO ELEMENTS

Investment

Return
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 PAYBACK MECHANISM

Investment and payback are related with few

variables.
a. Cash inflow b. Cash outflow.c. Payback period
d. Payback rule.

Payback period: The time span require to get back the

base money from the project

Payback rule ----If the calculated payback period is

less than or equal to some pre-specified payback period,
then accept the project. Otherwise reject .
PAYBACK MECHANISM

 A. Total investment of 20 lakh. The average profit from

3 years time is 10 lakh. As a result within 2 years of
time the total investment will be in hand.

 B. Total investment 20 lakh. The average profit per year

is 8 lakh. So the time of return back the investment is
2.05 year.

 C. Investment is 20 lakh .The average profit in three

years time will be 7 lakh. As a result the total time of
return back the investment is 2.85 years.
 Indicator is shortest possible time. The time of 2 years
time for money back will be regarded as the
acceptable project.
CONT
DISCOUNTING AND NON-
DISCOUNTING METHOD .
 Discounting and non-discounting method .

 The pay back mechanism could be analysis by discounting and non-

discounting method.

 A

1.Pay back period

 2. Return on Investment.

 In case of long term project the criteria could be

 B.

 Net present value(NPV)

 Benefit-cost Ratio (BCR)

 Internal rate of return.(IRR)

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WHAT IS NET PRESENT
VALUE(NPV)

 NPV=DPvB-Dpvc
 When,
 DPvB=Discounted Present Value of Benefit.
 DPvC=Discounted Present Value of Cost.
 If,NPV >0, project is undertaken.
 NPV<0, project is rejected.
 When NPV=0,project could be undertaken or rejected.

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NPV

 The NPV is the algebraic sum of the discounted values of

the incremental expected positive and negative net cash
flows over a projects anticipated lifetime.
 What does net present value mean ?
 Measures of the changes in wealth created by the project.
 If this sum is equal to zero then investors can expect to
recover their incremental investment and to earn a rate of
return on their capital equal to the private cost of funds
used to compute the present values.
 -Investors would be no further ahead with a zero-npv
project they would have been if they had the funds in the
capital market.
 In this case there is no change in wealth.
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CONT--

 When NPV is 0 but project is undertaken,

 If the goal is Social benefit.

 In case of export promotion Industry.
 When the project is considered as the alternate of any
imported product.
 When the project is required for a developing country.

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 Alternative Investment Criteria

BENEFIT-COST RATIO (BCR)

 This is another criteria of investment. It is the ratio of the PV

of the net cash inflows (or economic benefits) to the PV of the
net cash outflows (or economic costs):


PV of Cash Inflows (or Economic Benefits )

R
PV of Cash Outflows (or Economic Costs )

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 BENEFIT-COST RATIO (CONT’D)

Basic rule:

If benefit-cost ratio (R) >1, then the project should be undertaken.

Problems?

Sometimes it is not possible to rank projects with the Benefit-Cost Ratio

 Mutually exclusive projects of different sizes

 Mutually exclusive projects and recurrent costs subtracted out of

benefits or benefits reported gross of operating costs

 Not necessarily true that RA>RB that project “A” is better

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NPV SUMMARY

Net present value =

 Difference between market value (PV of

inflows) and cost
 Accept if NPV > 0
 Preferred decision criterion
 Net Present Value Profile
Net present value

120 Year Cash flow

0 – $200
100 1 50
2 100
80 3 150
4 0
60

40

20

– 20

– 40 Discount rate
2% 6% 10% 14% 18% 22%

IRR
ADVANTAGES AND DISADVANTAGES OF IRR

 Advantages
 closely related to NPV
 easy to understand and communicate

 Disadvantages
 may result in multiple answers
 may lead to incorrect decisions
 not always easy to calculate

 Very Popular: People like to talk in terms of returns

 99% use IRR Rule instead of 85% using NPV rule
IRR SUMMARY
Internal rate of return =
 Discount rate that makes NPV =
0
 Accept if IRR > required return
 Same decision as NPV with
conventional cash flows
 Unreliable with:
 Non-conventional cash flows
 Mutually exclusive projects
INTERNAL RATE OF
RETURN (IRR)
 Internal Rate of Return

 Discount rate that makes NPV=0

-Accept if IRR>required return
 -Same decision as NPV with conventional
cash flows.
 Unreliable with
 Non-conventional cash flows

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CONFLICTS BETWEEN
NPV AND IRR

 NPV directly measures the increase in

value to the firm

 Whenever there is a conflict between

NPV and another decision rule, always
use NPV

 IRR is unreliable in the following

situations:
 Non-conventional cash flows
 Mutually exclusive projects
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27
WHAT IS THE OUTCOME

 What are in your hand?

 Do you have any?
 If yes what ?
 If not why?
 Ask yourself.

 Learn more, Read more.

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CONT

 Basis of time estimate.

 Time study approach:

 The total time for the project is T
 The total of work is Q

Q=Total quantity of work

P=productivity factor ,i. e. output per man-day using normal method
of doing work.
n=normal size of crew