Criteria for assessing the economic efficiency of...

Criteria for assessing the economic efficiency of investments in real assets

After studying this chapter, the student must:


■ what is the difference between classical (cost) methods of analysis of investment investments in the creation of real assets from traditional (accounting) and non-standard (optional)

■ what analysts see as advantages and limitations of optional approaches to the analysis of investment decisions;

■ on what assumptions is the method of net present value ( NPV );

■ on what assumptions is the internal rate of return (IRR) method built and what are the limitations of its application

■ how the IRR method works at a changing barrier rate;

■ what are the advantages of MIRR

■ how to evaluate investment projects in a situation of limited capital;

be able to

■ realize the evaluation and ranking of projects within the accounting methods: payback period and average profitability;

■ Calculate the Fisher point for two projects and comment on the result;

■ Explain the advantages and disadvantages of various methods for assessing economic efficiency;

■ Identify the availability of optional project features;


■ the terminology of the economic evaluation of real investment projects;

■ skills in calculating the economic life of the project, payback period, NPV, IRR, MIRR, profitability index

■ skills of project matching using the NPV method for unequal lifetime projects and different scales;

■ Calculation skills 1RR (using the Excel, graphical method) for projects with standard and non-standard cash flows, with a changing interest rate on the market;

■ skills of ranking projects using the IRR method (including projects of different scale).

Key terms and concepts

■ flexibility in management decisions

■ payback period (payback period)

■ method of accounting (average) return

■ net present value method ( NPV)

■ economic life of the project

■ optimal economic life of the project

■ internal rate of return (IRR) and modified rate

■ The technique of analyzing the incremental flow

■ Fisher point

■ standard financial model flows

■ limited (limited) capital

■ profitability index

■ net profit margin

Various methods are used to evaluate the effectiveness of investments, which can be divided into three groups: traditional (accounting performance-based performance results), classical (generally accepted in modern investment analytics), and non-standard. Classical methods are based on a modern instrument of financial analysis - a model of discounted cash benefits (or discounted cash flow, DCF ), which was initially used to assess the market value (investment, fundamental) of financial assets of the market (stocks, bonds) , and later it was used to evaluate projects for the creation of real assets, real estate and a functioning business. This group includes methods such as NPV, APV, IRR, MIRR.

The advantages of the DCF approach include its availability and understandability to a wide range of users (owners of capital and managers), transparent logic, relative simplicity of calculations and the availability of special software to facilitate calculations (for example, software companies Alt and Expert System ).

However, this approach is not without flaws. First of all, it does not allow to adequately take into account the flexibility of management decisions and therefore does not work well for projects (industries) with a high degree of uncertainty.

Managerial flexibility is a combination of external and internal business performance parameters, in which the volatility of environmental factors creates special opportunities for building a new business model and generating greater profits. Situations and investment projects characterized by flexibility can not be fully and adequately evaluated by any of the traditional or classical approaches.

In the DCF design, it is assumed that the strategy for implementing a business idea (project) is fixed at the time of investing and then does not change. Note that the greater the freedom in changing the development trajectory of the company and the managers, the farther from the real picture is the estimate obtained by the method.

In addition, specific calculations require parameters that are not always easy to assess, and results often have a large share of subjectivity.

The method of real options (real options method, ROM) can be referred to nonstandard methods for estimating efficiency. An optional approach to evaluating investment projects in many situations has advantages over the DCF approach. It allows to take into account the additional value of managerial flexibility and quantitatively reflect the potential for future growth. Therefore, conceptually ROM more corresponds to the specifics of the decision-making situation in the conditions of uncertainty and the tasks of strategic management of the company.

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