Other project evaluation criteria, Equivalent annual income ECF, Profitability index РІ - Investment projects and real options in emerging markets

1.4. Other criteria for evaluating projects

ECF equivalent annual income

However, bringing two projects to the same life expectancy is not always possible, as it is not always possible to find a common term that is a multiple of the life of both projects. The second way to compare two projects with different lifetimes is to calculate the "financial performance" project, i. to estimate the average annual effect from its implementation.

Indeed, when we calculate NPV, we summarize all the cash flows and reduce them to one (zero) time point. Now our task is to evenly distribute NPV for the project implementation periods. In other words, it is required to find an annuity equivalent in income level to the analyzed project.

It is not difficult to understand (Figure 4.1.1) that the annual payment for such an annuity will be equal to

ECF Equivalent Annual Income

Fig. 4.1.1. Equivalent annual revenue ECF

Situation 4.1 (Continued)

Let's return to the two projects of the automobile plant described above. The ESD Criterion. Another method of comparing projects with different life expectancies that have a continuation beyond this period is to compare them by "financial performance" ECT, showing how much revenue the project process generates per year. For Project 1:

EST = WR,/& lt; 4y; about, 175 = 0,7 million USD. in year. For the doubled project 2:

ЕСТ = №РУ2/А5.0175 = 0,74 million USD per year.

That is, the infinitely long cyclic process of project 2, when the output of glass is doubled, generates a large net cash flow per year on average. Therefore, the average annual "financial performance" Project 2 is more.

With this approach, a project that has a continuation after the end of its life is considered not as a process that has a beginning and completion, but as an infinite in time cyclical process, which is all the better (with other things being equal) than a larger income per unit of time on average, it brings its initiators.

PI profitability index

Very often a large corporation or government structure, determining for itself the capital budget, plans to implement not one but several projects at once. Before it, thus, there arises the problem of creating a rational project complex, or a portfolio consisting of several projects.

In the simplest case, the task can be set as follows: which projects should be selected in the portfolio, so that the effect of the entire investment package is maximized?

You can rank all projects of the company in descending order NPV, and then include them in the portfolio in accordance with their rank until the budget is exhausted. However, the project complex with the atom is most likely not optimal, and in sum all the projects do not necessarily give a maximum of NPV.

This is explained by the scale effect: you can select only one project with the maximum value of NPV, but it is likely that it will not be the most profitable for one ruble of invested funds and its maximum net present value will be explained only by those , that this project is the largest.

It may well be that it is better to implement for the same money five smaller projects, more profitable per unit of investment. Each of these projects will have a lower value of NPV, since they are smaller in scale, but in sum these five projects will give a more significant integral effect.

From what has been said, it follows that if the project has a maximum value of NPV, , it does not mean that it's the one that needs to be implemented. A few smaller projects can add up to a more impressive result, just as one genius can achieve less success in his field than a coherent team of five professionals.

According to many, the criterion for selecting projects in a portfolio can be, with this approach, the profitability index (RG), representing the project's NPV per unit of investment invested in it .

Another modification of this indicator is the ratio of cash inflows for the project to investments or (in another variant) to cash outflows:

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