PROJECT APPRAISAL

Project appraisal is a costs and benefits analysis of different aspects of proposed project with
an objective to adjudge its viability.
Project appraisal is a process of transmitting information accumulated through feasibility
studies into a comprehensive form in order to enable a decision maker undertake a comparative
appraisal of various projects. Different methods are used by the lending institutions to evaluate
a project appraisal. Marketing, Economic, financial, management and social feasibilities are
studied by lenders/investors as well. The various profitability appraisal methods used for
evaluation are:
1.
2.
3.
4.
5.
6.

Payback period method

Return on investment method
Discounted cash flow method
Internal rate of return method
Net present value
Profitability index

Payback period technique:

One of the most commonly used techniques for evaluating investment proposal is the cash
payback or payback period. It attempts to calculate the period known as payback period
required to recover the initial investment out of inflow of net cash flows/savings or profit from
the investment. In other words, it represents the number of years in which the investment is
expected to pay for itself
Payback period=(Original cost of investment/Annual net cash inflows or savings)
P=I/S or I/C or I/E
Where,
P= Payback period
I=Initial Investment
S=Savings per year
C=Annual cash inflow
E=Earnings per year
This method is suitable for relatively small projects that are expected to be completed in a
short time.
Return on investment (ROI):
ROI is defined as the ratio of profit to initial capital outlay. The figure is compared to the cost
of the capital. If the project does not yield the desired ROI, it is not accepted. If there are a
number of projects under consideration, then they are ranked on the basis of ROI and the
project with the best ROI or those above the desired ROI is/are selected. Different methods are
used for the purpose of calculating ROI. Average Rate of Returns=(Annual net income/Average
Investment)*100Average investment=Initial investment + Scrap value/Life of assets.

Discounted cash flow:

Money has time value
. It means that the value of money changes over time. An amount of Rs.100 received after one
year will not have the same value that it has today. The cash flow received in different years
have different values. In earlier methods, time value of money was not taken into account.
Discounting is the opposite of compounding. In compounding, the rate of interests, the future
value of the present money is ascertained. In discounting, the present value of the future money
is calculated to enable us to make decisions today.
Internal Rate of Return:
The life of the project is usually fixed and the discount rate at which the present value of net
cash inflow during the chosen life equals the initial outlay. In other words, it reduces the net
present value to zero. The IRR is arrived at through an iterative process and for different
lengths of life of the project.
Net present value:
In this method, the discount rate should be equal to the companys weighted cost of capital. In
this method, future cash inflows are discounted to the present value. This is the Gross Present
Value of the cash flows. From this, the present value of the cost of the project is subtracted.
The resulting surplus is the net present value of the investment. The best project is the one,
which has the highest net present value.
Profitability Index:
It is also called present value profitability index or benefit cost ratio. Profitability
Index=(Present value of gross cash inflows/Initial cash outlay)Present value index=(Present
value of operating inflows/Present value of Net Investment)*100
Risk adjusted Discount rate:
In risk-adjusted discount rate (RADR), the discount rate is adjusted in accordance with the
degree of risks. Higher the risk, higher the discount rate. An entrepreneur must be
knowledgeable about profitability appraisal methods. This will help him evaluate his business
ideas and in preparation of project reports.