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Methods for investment evaluation

There are several quantitative methods used for investment evaluation. Each of them has its advantages and disadvantages and it is not unusual to use them in combination.    It is appropriate to use the methods which can evaluate (either in itself or in combination): payback –

Discounted cash-flow (DCF)

Discounted cash-flow is the technique based on the concept of time value of money on which a number of investment appraisal methods are based. It comes out from future relevant cash-flows projections, discounts them to present value which is further used to calculate for example: Net present valu

Present value (PV)

Present value (PV) is the nowadays value of future cash-flows which is calculated from future value (FV) via discounting.   Formula Discount factor can be either calculated or easily found for each possible discount rate and year in discount tables. 

Perpetuity

Perpetuity is annuity that will be received or paid for ever.   Present value (PV) formula for perpetuity  

Future value (FV)

Future value (FV) is the future value of the present cash-flows.  Future value is calculated from present value (present cash-flows) via compounding.   Formula   The discount factor for each considered year and discount rate can be either calculated or easily found in discount t

Modified internal rate of return (MIRR)

Modified internal rate of return (MIRR) is less frequently used method for investment appraisal that is based on discounted and compounded cash-flow methodology. It was developed to overcome the following disadvantages of internal rate of return (IRR): complex calculation unrealistic assumption

Return on investment (ROI)

Return on investment (ROI) is the indicator used to evaluate the investment profitability. It is calculated as the accounting profit arising as the consequence of the investment divided by the investment costs.  The higher is the calculated return, the better.   ROI formula is either th

Time value of money

Time value of money is based on the assumption that each dollar earned today is worth more than in the future, and vice versa. The reasoning behind it lies in the fact that the interest would be charged on the savings in the meantime. (29) Time value of money is incorporated to investment appraisal

Annuity

Annuity is a fixed payment made at regular intervals during a specified period. When a loan is repaid in annuity, the installment usually consists of principal repayment and interest expense where the principal repayment increase and interest expense decrease over time.   How to discount an

Compounding

Compounding is the method that transforms present value (current cash-flows) into future value (FV).  Because of the time value of money concept, the future value of equivalent present cash-flows will be higher because interest could have been charged to the cash savings over time.

Discount rate

Discount rate is the rate of return (interest rate) used in discounted cash-flow calculations. Most often, it is cost of capital, but other rates are also possible. Discount rate can be: cost of capital, most often WACC – the most common discount rate specified minimum target rate of

Discounted payback period / Adjusted payback period

Discounted payback period (or Adjusted payback period) is the method used to evaluate the investments. It was developed to overcome the biggest disadvantages of traditional payback period method that it ignores time value of money and is possibly calculated based on profit, not cash-flow. Discounted

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