112 Financial Management

Chapter-5

Capital Budgeting Evaluation Techniques

Methods of Appraisa

Investment appraisal methods can be divided into two basic areas. One in which no
time value of money is taken into consideration and one in which it is. Using time value
of money while evaluating projects is knownas discounting.
A. Non-Discounting Methods
Urgency
Payback Period
Accounting Rate of Return
Debt Service Coverage Ratio
B. Discounting Methods
Net Present Value
Profitability Index
Internal Rate of Return

C. Economic Value Added (EVA) charnm as a Performance Measure

Non-discounting Methods

Urgency

According to this critera, 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? In
certain situations, of course, it may not be difficult to identify highly urgent investments.
For example, some minor equipment may have to be replaced immediately due to failure,
to ensure continuity of production. Non-replacement of such equipment may mean
considerable losses arising from stoppage in production. It may be futile in such a case
to go into detailed analysis and delay decision.

In view of these limitations of the urgency criterion, we suggest that in general it should
not be used for investment decision making. In exceptional cases, where genuine urgency
exists, it may be used provided investment outlays are not significant.