Topic №11: Evaluation of financial and economic efficiency of investment projects

Profitability index (PI)

• Profitability index (PI);
• which measures the extent to which increases the value of the company based on 1 soum investment.
• The higher the PI, the greater the returns of each soum invested in the project. Due to this the figure is very handy when you select one project from a number of alternative, having approximately the same NPV.

• The Formula is as follows:
• or

• If PI > 1, the project is acceptable.
• PI = 1, the project is neither profitable nor unprofitable.
• PI < 1, the project is not accepted, unprofitable.

Internal rate of return (IRR)

• Internal rate of return (IRR)- is the value of the discount rate at which NPV equals zero. There are 2 ways to find IRR:
• - Calculate it using the equations of calculation of the present value;
• - To find it in the table of coefficients cast

• Procedure for determining the IRR can formally express this equation that should be solved regarding r:
• (Процедуру определения IRR можно формально выразить таким уравнением, которое следует решить относительно r:)

This figure indicates the expected profitability of the project and, therefore, the maximum relative (нисбий) level of costs that may be associated with this project. For example, if the project is fully financed by a commercial bank loan, the value of IRR shows the upper limit of the allowable level of bank interest rate above which makes the project unprofitable.

• This figure indicates the expected profitability of the project and, therefore, the maximum relative (нисбий) level of costs that may be associated with this project. For example, if the project is fully financed by a commercial bank loan, the value of IRR shows the upper limit of the allowable level of bank interest rate above which makes the project unprofitable.

Discount payback period (DPP)

• Discount payback period (DPP)– determines the recovery of the investment required for the period of time over which the investment will pay off discounted cash flow derived from the project.
• Under the payback period refers the length of time. During which the sum of discounted future income will be equal to the amount of money invested in the initial period of time.

• The Formula is as follows:

Task 14. The enterprise plans expansion of production by purchase of the new technological line. There are two offers (see the table).
Basic data by options of the technological line
The planned sales by years: in the 1st year — 210 products; in the 2nd — 260; in the 3rd - 370; in the 4th - 320; in the 5th - 300 products.
Service life of the technological line — 5 years. Upon termination of operation the technological line is liquidated.
Income tax — 24%.
The enterprise has own capital - 150 U.C., therefore by option B additional investments are attracted in a form credit for 5 years under 30% per annum with repayment, since 1st year of operation (at the end of the year).
The profitability rate on own capital — 20%.
Define the best option of investments. Using static and dynamic methods for assessing the effectiveness of investments , determine the feasibility of the project.