SINGLE PROJECT EVALUATION METHODS

1. Rate of Return method (ROR)

 Rate of return is a measure of the effectiveness of an investment of capital. It is a
financial efficiency
 When using this method, it is necessary to decide whether the computed ROR is
sufficient to justify the investment
 The method is easily understood by management and investors
Conditions:
o A single investment of capital at the beginning of the first year of the project
life and identical revenue and cost data for each year
o The capital invested is the total amount of capital investment require to
finance the project whether equity of borrowed

𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑝𝑟𝑜𝑓𝑖𝑡

𝑅𝑎𝑡𝑒 𝑜𝑓 𝑟𝑒𝑡𝑢𝑟𝑛 =
𝑐𝑎𝑝𝑖𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑠𝑡𝑒𝑑

2. Annual Worth (AW) method

 The interest on the original investment (also called as the minimum required profit) is
included as a cost.
 If the excess of annual cash inflows over annual cash outflows is not less that zero,
then the proposed investment is justified
 The method is covered by the same limitation as the rate of return pattern initial of
investment of capital and uniform revenue and cost throughout the life of the
investment

3. Present Worth (PW) method

 This method is based on the concept of present worth
 If the present worth of the cash net flows is equal to, or greater that zero, the project
is justified economically
 The present worth method is flexible and can be used for any type of economy study.
 It is used extensively in making economy studies in the public work field where long-
lives structures are involved

4. Future Worth (FW) method

 The method is almost similar to the present worth method except that all cash inflows
and outflows are compounded forward to a reference point in time called the future.
 If the future worth of the net cash flows is equal to, or greater than zero, then the
project is economically justified
 5. Payback (Payout) Period method
 The method is commonly defined as the length of time required to recover the first
cost of an investment from the net cash flow produced by that investment for an
interest rate of zero

𝑖𝑛𝑣𝑒𝑠𝑡𝑚𝑒𝑛𝑡 − 𝑠𝑎𝑙𝑣𝑎𝑔𝑒 𝑣𝑎𝑙𝑢𝑒

𝑃𝑎𝑦𝑜𝑢𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 (𝑦𝑒𝑎𝑟𝑠) =
𝑛𝑒𝑡 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑎𝑠ℎ 𝑓𝑙𝑜𝑤

Problem:
An investment of 270,000 can be made in a project that will produce a uniform annual revenue
of 185,400 for 5 years and then have a salvage value of 10% of the investment. Out-of-the-pocket
costs of operation and maintenance will be 81, 000 per year. Taxes and insurance will be 4% of
the first cost per year. The company expects capital to earn not less than 25% before income
taxes. Is this a desirable investment? What is the payback period of the investment?
Problem:
A businessman is considering building a 25-unit apartment in a place near a progressive
commercial center. He felt that because of the location of the apartment it will be occupied 90%
of all time. He desires a rate of 20%. Other pertinent date are the following:
Land investment = 5,000,000
Building investment = 7,000,000
Study period = 20 years
Cost of land after 20 years = 20,000,000
Cost of building after 20 years = 2,000,000
Rent per unit per month = 6,000
Upkeep per unit per year = 500
Property taxes = 1%
Insurance = 0.05%