Projects Appraisal

Appraisal Criteria for Projects

There are two broad categories of appraisal criteria: non-discounting criteria and discounting criteria.

The important non-discounting criteria are :

Urgency,
Payback period
Accounting rate of return
Debt service coverage ratio

The important discounting criteria are:

Net Present Value
Benefit Cost Ratio
Internal Rate of Return
Annual Capital Charge

According to urgency criterion projects which are deemed to be more urgent get priority over projects which are regarded as less urgent. The problem with this criterion is: How can the degree of urgency be determined?
The payback period is the length of time required to recover the initial cash outlay on the project. According to this criterion, a project is acceptable if its payback period is less than certain specified payback period.
The Accounting Rate of Return also referred to as the average rate of return, is a measure of profitability which relates income to investment, both measured in accounting terms. A project is deemed acceptable if its accounting rate of return exceeds a certain cut off rate of return.
The net present value of a project is equal to the sum of the present value of all the cash flows (outflows and inflows) associated with the project. A project is acceptable if its net present value exceeds zero.
Benefit Cost Ratio (Present Value of Benefits—Initial Investments) divided by Initial Investment. A project is feasible if the benefit cost ratio exceeds 0
The internal rate of return of a project is the discount rate that makes net present value equal to zero. A Project is acceptable if its rate of internal return exceeds the cost of capital.

So we see that the most commonly used method for evaluating small sized investments is the payback method. For larger investments accounting rate of return and recently discounted cash flow methods are commonly employed.

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