Assignment for PGPM 21

1. INTRODUCTION

Project Formulation and Appraisal play a critical role in entrepreneurship

development and enterprise creation. Most rejections and failures of project
proposals are due to improper business planning. Varying appraisal methods and
project formats (varying from bank to bank and financial institution to financial
institution) compound the complexity. Formulating viable project reports for small,
micro, village and cottage industry is a fine art requiring skills different from what is
needed in case of large and medium enterprises. Though a good project report is
the heart of entrepreneurship, potential entrepreneurs lack formulating skills and
their trainer–promoters, knowledge of training/consulting methods. Even
experienced trainers/consultants are often unclear on the treatment required
for different projects: industry, service or business.

Project Analysis is done to Estimate, Compare, and Rank the project net benefits
among different alternatives with budget constraints. Project appraisal is a generic
term that refers to the process of assessing, in a structured way, the case
for proceeding with a project or proposal. In short, project appraisal is the effort
of calculating a project's viability. It often involves comparing various options,
using economic appraisal or some other decision analysis technique. The
economic and financial appraisals (ex-anti evaluation) are considered to be the
most important tools for helping decision maker to choose or select.

2. WHAT IS A PROJECT?

"A project is a group of activities which can be planned, financed (funded),

implemented, and analyzed as a unit".

In project management, a project consists of a temporary endeavor undertaken

to create a unique product, service or result. Another definition is a management
environment that is created for the purpose of delivering one or more business
products according to a specified business case.
Project objectives define target status at the end of the project, reaching of which is
considered necessary for the achievement of planned benefits. They can be
formulated as SMART criteria: Specific, Measurable (or at least evaluable)
achievement, Achievable (recently Agreed-to or Acceptable are used regularly as

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well), Realistic (given the current state of organizational resources) and

Time terminated (bounded). The evaluation (measurement) occurs at the project
closure. However a continuous guard on the project progress should be kept by
monitoring and evaluating. It is also worth noting that SMART is best applied for
incremental type innovation projects. For radical type projects it does not apply as
well. Goals for such projects tend to be broad, qualitative, stretch/unrealistic
and success driven.

The project in general includes the following

factors

(a) Outflow
s
Also known as; inputs, resources, costs or
investments

(b) Inflows
Also known as: output, production, benefits or
revenues.

(c) Life span of the

project
The time or the life of the project. It is a specific activity(ies) with a specific
starting point and specific ending point intended to accomplish a specific
objective(s).

(d) A space
A geographical location or a place with a boundary forming the project
space

(e) The
management
The administrative structure, the individuals (coop., corp., entities) and
the participants.

It is better to keep the project close to the minimum size that is economically,
technically, and administratively feasible

3. THE PROJECT CYCLE

The project cycle comprises of (i) Project Identification, (ii) Project Preparation or
Formulation (feasibility studies), (iii) Project Appraisal (Ex-ante Evaluation),
(iv) Project Implementation, and (v) Project Evaluation (Ex-post Evaluation).

(i) Project
Identification

Any project starts with an idea, which leads the identification of the relationship
between the idea and the sector plan, then with the national plan as a whole which
also includes the identification of the opportunity cost of the alternative investments

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(ii) Project Preparation or Formulation (feasibility studies)

This stage includes the different feasibility studies such

as:

(a) Technical
feasibility
(b) Commercial feasibility (marketing
study)
(c) Financial
feasibility
(d) Economic feasibility, and
etc.

This stage ends with a project

report

(iii) Project Appraisal (Ex-ante Evaluation)

It includes economic, financial, and social evaluation for the project before its
implementation to have enough understanding whether the project is feasible
or not.

(iv) Project Implementation

This stage includes observing the project scheduling, supervising, and control the
different stages. Also to record what has happened in each stage of the project
implementation (project reporting, or sometime known as follow up reports).

(v) Project Evaluation (Ex-post Evaluation)

It includes the financial, economic, and social evaluation after the project is
implemented. The difference between Stages 3 and 5 (even the used measures
are the same) is that: in stage 3 (the Appraisal stage) is estimated but stage 4 is
what actually happened (The Evaluation Stage).

4. ASSESSMENT AND APPRAISAL OF A PROJECT

The following are the common steps for the Assessment and Appraisal of any
project
• Identify the project costs and
benefits
• Quantify the project costs and
benefits
• Conduct a cost benefit
analysis
• Assess the economic and financial feasibility of the project by estimating
the various profitability indicators of the project

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• Conduct sensitivity analysis scenarios, whenever

needed.
• Accept or reject a project or a set of project according to a set of
choice criteria
The two techniques for the assessment and appraisal of the projects are (i) Non-
Discounted Technique and (ii) Discounted Technique.

(i) Non-Discounted
Technique
Non-discounted technique of Capital Budgeting refers to the technique or
method of investment decision where it is considered that there is no change in
the price level between the initial investment made and the date of last return
from the investment. Under this technique, the future value of money is
considered at the current value.

The non-discounted techniques are as

follows:-

(a) Pay Back Period (PBP)

Method
Pay Back Period refers to the period (generally number of years) of an investment
project proposal at which the firm expects to recover its initial investment to the
project proposal. Alternatively the PBP is the period at which the total cash inflow
from a project equals to the initial investment (i.e. cash outflows) made to the
project.

Computation of PBP
(i) When the Cash Inflows After Tax (CFAT) are constant every
year PBP = Initial Investment / Constant CFAT per annum

(ii) When CFAT are not constant every year, the following steps are to
be followed :
Step 1:- Calculate the CFAT of each year 
Step 2:- Compute the cumulative CFAT
Step 3:- The time (i.e. year) when the cumulative CFAT becomes equal to
the initial investment would be the PBP or else, use the method
of interpolation.

Under this method, the project having the shortest PBP should be
undertaken
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(b) Pay Back Profitability

Method
Pay Back Profitability is the amount of cash flows earned from a project after its
Pay Back Period. Alternatively, it is the excess of cash inflows from a project over
the initial investment into the project. It represents the net cash inflows from the
project proposal.

Computation of Pay Back Profitability

(i) When (CFAT) are constant every
year 
Pay Back Profitability = (Expected life of the project – PBP) x
CFAT

(ii) When CFAT are not constant every

year 
Pay Back Profitability = Total CFAT – Initial
Investment

(c) Average Rate of Return (ARR)

Method
ARR is the method of investment appraisal which determines return on
investment by totaling the cash flows (over the years for which
the money was invested) and dividing that amount by the number of years.
The average rate of return does not assure that the cash inflows are the
same in a given year; it simply guarantees that the return averages out to
the average rate of return.
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This method is based on accounting information rather than cash

flows. There are various ways of calculating Average Rate of Return. It
can be

Average annual Profit after Tax

ARR = x 100
Average Investment

Total of after Tax Profit of all the year

Average Annual Profit = x 100
No. of years

Original Investment + Salvage Value

Average Investment =
2

Average Investment Original Investment - Salvage Value

2 + Salvage Value
=

calculated
as:-

If working Capital is also required in the initial year of the project, the
average investment will be= Net working Capital + Salvage value + ½ (initial
cost of Machine- Salvage Value).
In another method instead of average investment original cost is
used.
In this method, to evaluate the project all those projects are accepted on
which average rate of return is more than the predetermined rate. Thus, the
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project is given more significant on which the average rate of return is the
highest.
Acceptance Rule
Accept if ARR > minimum rate.

Merits
1) Easy to understand. Necessary information to calculate average
rate of return are available easy.
2) This method takes into account all the profits during the life time of
the project, whereas pay back period ignores the profits accruing
after the pay back period.
3) Give more weightage to future receipts.
4) Easy to understand and calculate.
5) Uses accounting data with which executives are familiar.

Demerits
1) Ignore the time value of money.  
2) Does not use cash flow.
3) No objective way to determine the minimum acceptable rate
of return.
4) This method does not account for the profits arising on sale of
profit
on old machinery on replacement.
5) ARR method does not consider the size of investment for each
project. It may be time that the competing ARR of two projects may
be the same but they may require different average investments. It
becomes difficult for the management to decide which project should
be implemented.

(ii) Discounted
Technique

Discounted Technique is a method of investment analysis in which anticipated

future cash income from the investment is estimated and converted into a rate
of return on initial investment based on the time value of money. In addition, when
a required rate of return is specified, a net present value of the investment can
be estimated.
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The discounted techniques are as follows:-

(a) Discounted Pay Back Period (PBP)

Method

The discounted payback period is the amount of time that it takes to

cover the cost of a project, by adding positive discounted cash flowcoming
from the profits of the project.

In investment decisions, the number of years it takes for an investment to

recover its initial cost after accounting for inflation, interest, and
other 
matters affected by the time value of money, in order to be worthwhile to
the investor . It dfifers slightly from the payback period rule, which
only accounts for cash flows resulting from an investment and does not take
into account the time value of money. Each investor determines his/her
own discounted payback period rule and, as such, it is a highly subjective
rule. In general, however, short-term investors use a short number of years,
or even months, for their discounted payback period rules, while long-term
investors measure their rules in years or even decades.

(b) Profitability Index (PI) Method

Profitability Index (PI) is the ratio of the Present Value (PV) of the total cash
inflows from a project and the PV of the total cash outflows for the project. PI
is also called the “benefit-cost ratio”.

PI = PV of total cash inflows

PV of total cash
outflows

If PI is less than 1, accept the project proposal,

If PI is greater than 1, reject the project
proposal
If PI is equal to 1, the management may be indifferent in accepting
or rejecting the project proposal. Generally the project proposal is rejected
in such a case as the firm does not get the net benefit from it.

(c) Net Present Value (NPV) Method

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Net Present Value (NPV) is the difference between the PV of the total cash
inflows from a project and the PV of the total cash outflows for the
project.

NPV = Total of PV of cash Inflows - Total of PV of cash outflows

%0%.e ., the total of discounted cash inflows - the total of
discounted cash outflows

Following steps are to be followed for determining the NPV:

Step 1: Calculate the CFAT of each year
Step 2: Multiply the CFAT of each year by the respective PV factor and get
the discounted CFAT or PV of CFAT.
Step 3: Compute the cumulative discounted CFAT
Step 4: Compute the PV of cash outflows.
Step 5: Calculate the NPV by deducting the PV of the total cash outflows
from the PV of the total cash inflows.

Decision-Making Criterion
i. In case of a single project proposal, accept it if NPV > 0; else
reject it.
ii. In case of two mutually exclusive project proposals, accept
the project having the higher NPV.

(d) Internal Rate of Return (IRR) Method

Internal Rate of Return (IRR) is the rate of return which equates the PV of
the total cash inflows with the PV of the total cash outflows. Therefore, IRR
is the rate of return (i.e. the discounting factor) which makes the NPV zero.

At the IRR, PV of total cash inflows = PV of total cash outflows

Hence, PI = 1.

Decision-Making Criterion
iii. In case of a single project proposal, accept it if the
IRR exceeds the cost of capital.

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iv. In case of two mutually exclusive project proposals, accept the

project having the higher IRR.

ASSUMING THE FOLLOWING HYPOTHETICAL WATER RESERVOIR PROJECT

A water reservoir project to irrigate agricultural land that used to be in rain fed was
designed. The estimated costs and benefits of the project in millions of US $ are
displayed in Table 1.
The task is to calculate the project NPV, BCR at 10% Discounted rate. In addition,
we need to determine the project IRR.

Table 1: The annual estimated costs and benefits for the project
Year Investment O&M ($) Total C ost Benefits
($) 2.00 ($) ($)
1 15.00 17.00 5.00
2 10.00 2.50 12.50 8.00
3 10.00 3.00 13.00 11.00
4 0.00 5.00 5.00 15.00
5 0.00 5.00 5.00 15.00
6 12.00 5.00 17.00 10.00
7 0.00 5.00 5.00 15.00
8 0.00 5.00 5.00 15.00
9 0.00 5.00 5.00 15.00
10 0.00 5.00 5.00 15.00
Total 47.00 42.50 89.50 124.00

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Solution :
-
Table 2: The Project NPC and BCR as 10% Discount Rate
Year Investment O&M Total Benefits DF D C ost D NPV
Cost Benefit
($) ($) ($) ($) 10% ($) ($) ($)
-
10.9
1 15.00 2.00 17.00 5.00 0.909091 15 45 4 55 0
2 10.00 2.50 12.50 8.00 0.826446 10 33 6 61 -3 72
3 10.00 3.00 13.00 11.00 0.751315 9 77 8 26 -1 51
4 0.00 5.00 5.00 15.00 0.683013 3 42 10 25 6 83
5 0.00 5.00 5.00 15.00 0.620921 3 1 9 31 6 21
6 12.00 5.00 17.00 10.00 0.564474 9.6 5.64 -3.96
7 0.00 5.00 5.00 15.00 0.513158 2.57 7.70 5.13
8 0.00 5.00 5.00 15.00 0.466507 2.33 7.00 4.67
9 0.00 5.00 5.00 15.00 0.424098 2.12 6.36 4.24
10 0.00 5.00 5.00 15.00 0.385543 1.93 5.78 3.85
Tot 10.8
al 47.00 42.50 89.5 124.00 60.62 71.46 4

Benefit Cost Ratio = 71.46 / 60.62 = 1.179

NPV = 10.84

Table 3: The Project NPC and BCR as 20% Discount Rate

Year Investment O&M Total Benefits DF D C ost D NPV
Cost Benefit
($) ($) ($) ($) 20% ($) ($) ($)
-
10.0
1 15.00 2.00 17.00 5.00 0.833333 14.17 4.17 0
2 10.00 2.50 12.50 8.00 0.694444 8.68 5.56 -3.12
3 10.00 3.00 13.00 11.00 0.578704 7.52 6.37 -1.15
4 0.00 5.00 5.00 15.00 0.482253 2.41 7.23 4.82
5 0.00 5.00 5.00 15.00 0.401878 2.01 6.03 4.02
6 12.00 5.00 17.00 10.00 0.334898 5 69 3 35 -2 34
7 0.00 5.00 5.00 15.00 0.279082 1 40 4 19 2 79
8 0.00 5.00 5.00 15.00 0.232568 1 16 3 49 2 33
9 0.00 5.00 5.00 15.00 0.193807 0 97 2 91 1 94
10 0.00 5.00 5.00 15.00 0.161506 0 81 2 42 1 61
Tot
al 47.00 42 50 89 5 124.00 44 82 45 72 0 90

Benefit Cost Ratio = 45.72 / 44.82 = 1.020

NPV = 0.90
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Table 4: The Project NPC and BCR as 30% Discount Rate

Year Investment O&M Total Benefits DF D C ost D NPV
Cost Benefit
($) ($) ($) ($) 30% ($) ($) ($)
1 15.00 2.00 17.00 5.00 0.769231 13.08 3.85 -9.23
2 10.00 2.50 12.50 8.00 0.591716 7.4 4.73 -2.67
3 10.00 3.00 13.00 11.00 0.455166 5 92 5 01 -0 91
4 0.00 5.00 5.00 15.00 0.350128 1 75 5 25 3 50
5 0.00 5.00 5.00 15.00 0.269329 1 35 4 04 2 69
6 12.00 5.00 17.00 10.00 0.207176 3 52 2 07 -1 45
7 0.00 5.00 5.00 15.00 0.159366 0 8 2 39 1 59
8 0.00 5.00 5.00 15.00 0.122589 0.61 1.84 1.23
9 0.00 5.00 5.00 15.00 0.094300 0.47 1.41 0.94
10 0.00 5.00 5.00 15.00 0.072538 0.36 1.09 0.73
Tot -
al 47.00 42 50 89 5 124.00 35 26 31 68 3.58

Benefit Cost Ratio = 31.68 / 35.26 = 0.8985

NPV = -3.58

Table 5: INTERNAL RATE OF RETURN

Year Investment O&M Total Benefits DF D C ost D NPV
Cost Benefit
($) ($) ($) ($) 21.40% ($) ($) ($)
1 15.00 2.00 17.00 5.00 0.823723 14 4.12 -9.88
2 10.00 2.50 12.50 8.00 0.67852 8.48 5.43 -3.05
3 10.00 3.00 13.00 11.00 0.558913 7.27 6.15 -1.12
4 0.00 5.00 5.00 15.00 0.460389 2 3 6 91 4 61
5 0.00 5.00 5.00 15.00 0.379233 1.9 5.69 3.79
6 12.00 5.00 17.00 10.00 0.312383 5 31 3 12 -2 19
7 0.00 5.00 5.00 15.00 0.257317 1 29 3 86 2 57
8 0.00 5.00 5.00 15.00 0.211958 1 06 3 18 2 12
9 0.00 5.00 5.00 15.00 0.174595 0 87 2 62 1 75
10 0.00 5.00 5.00 15.00 0.143818 0.72 2.16 1.44
Tot
al 47.00 42 50 89 5 124.00 43 20 43 24 0 04

Benefit Cost Ratio = 43.24 / 43.20 = 1.0009

NPV = 0.04

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INCREASING THE DIMENSIONS OF PROJECTS’ FEASIBILITY AND APPRAISAL

The following issues are becoming increasingly crucial factors in assessing

and determining the feasibility of a project or a set of projects

1. The environmental impact of the project

2. The interdependencies among projects
3. Fund limitations (Capital Constraint)

From scenic beauty and recreational opportunities to direct inputs into the production
process, environmental resources provide a complex set of values to individuals and
benefits to society. Coastal areas, for example, offer scenic panoramas and
radiant sunsets. Fish and other edible sea life caught in coastal areas provide a rich and
nutritious source of food to consumers. Beaches are also excellent recreation areas,
used for relaxation, exercise, or bird watching. These are only the direct benefits. There
are also values that are not directly tied to use, such as climate modulation, physical
protection, and stewardship for future generations. All of these benefits are relevant in
environmental valuation.

Environmental Values
Use values, such as fishing and hiking, are the more direct and quantifiable category
of environmental values, but they capture only a portion of the total economic value of
an environmental asset. Indirect-use values, non-use values, and intrinsic values are
also associated with preserving environmental resources. Total economic value is
represented by the following equation:

Total economic value = direct-use value + indirect-use value + non-use value +

intrinsic value

Indirect-use values associated with coastal areas include biological support,

physical protection, climate modulation, and global life support. Non-use values are less
direct, less tangible benefits to society and include option and existence values. The
option value is the value an individual places on the potential future use of the
resource, for example, benefits a beach would offer during future trips to the coastal
area. Existence values
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include bequest, stewardship, and benevolence motives. Bequest value is the satisfaction
gained through the ability to endow a natural resource on future generations.
The stewardship motive is derived from an altruistic sense of responsibility
toward the preservation of the environment and a desire to reduce environmental
degradation. The benevolence motive reflects the desire to conserve an
environmental resource for potential use by others. Finally, the intrinsic value of nature
reflects the belief that all living organisms are valuable regardless of the monetary value
placed on them by society.

It is important to note that there are certain environmental assets that are absolutely
essential to the support of animal life, and that the total value of these assets is not
definable. Marginal changes, however, in the productivity and security of even
irreplaceable environmental assets (e.g., the degradation of part of a large ecosystem or
environmental resources essential to human life) can be captured in terms of total
economic value. For example, the total economic value of air and water quality are
immeasurably large because extreme degradation of either would result in irreversible
and catastrophic damage to the capacity of this planet to support human and other
life. However, we can observe the finite value that society places on small losses of
even those assets that are absolutely essential for sustaining life. For instance,
society has proven willing to accept some degradation of air quality to improve the
efficiency and convenience of transportation. In this particular example, individual choices
are not a good indicator of the value of air quality since most of the costs of reduced
air quality are externalized or passed on to others

Methods for Valuing the

Environment

Environmental valuation is largely based on the assumption that individuals are willing to
pay for environmental gains and, conversely, are willing to accept compensation for some
environmental losses. The individual demonstrates preferences, which, in turn,
place values on environmental resources. That society values environmental
resources is certain; monetizing the value placed on changes in environmental assets
such as coastal areas and water quality is far more complex. Environmental economists
have developed a number of market and non-market-based techniques to value the
environment. Figure 2 presents some of these techniques and classifies them
according to the basis of the monetary valuation, either market-based, surrogate
market, or non-market-based.
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Figure 2. Environmental Valuation Methods

Market-Based Methods Economists generally prefer to rely on direct, observable market
interactions to place monetary values on goods and services. Markets enable economists
to measure an individual's willingness to pay to acquire or preserve environmental
services. In turn, consumers reveal their preferences through the choices they make in
allocating scarce resources among competing alternatives. There are a number of
market- based methods of environmental valuation. This article identifies and
discusses three market-based techniques: a) factor of production approach, b)
change in producer/consumer surplus, and c) examination of defensive expenditures.

The value of a natural resource can be monetized based on its value as a factor
of production. An Economic View of the Environment notes that the output of any firm is
a function of several important inputs (e.g., land, capital, natural resources), which
are collectively known as "factors of production." In their role as factors of production,
raw materials and environmental inputs are used in the production of other goods.
When a natural resource has direct value as a factor of production and the
impact of environmental degradation on future output of that resource can be accurately
measured, the resultant monetary value of the decline in production or higher cost of
production can be measured. For example, a decline in water quality could have a direct
and detrimental impact on the productivity and health of shellfish beds. This technique is
methodologically straightforward; however, it is limited to those resources that are used
in the production process of goods and services sold in markets. Because many
goods and services produced by the environment are not sold in markets, the factor of
production method generally fails to capture the total value of the resource to society.

A final market-based valuation method is that of defensive expenditures, which are

made on the part of industry and the public either to prevent or counteract the adverse
effects of pollution (Feather 1995) or other environmental stressors. The
defensive
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expenditures method, also known as the averting behavior approach, monetizes

an environmental externality by measuring the resources expended to avoid its
negative impacts on a surrounding community. Types of defensive expenditures
include water purification devices, beach nourishment, and replanting seagrasses.

Surrogate Market Methods. In the absence of clearly defined markets, the value
of environmental resources can be derived from information acquired through
surrogate markets. The most common markets used as surrogates when monetizing
environmental resources are those for property and labor. The surrogate market
methods discussed below are the hedonic price method and the travel cost method,
with a brief look at the use of random utility models for environmental valuation.

The hedonic price method of environmental valuation uses surrogate markets for placing
a value on environmental quality. The real estate market is the most commonly used
surrogate in hedonic pricing of environmental values. Air, water, and noise pollution have
a direct impact on property values. By comparing properties with otherwise
similar characteristics or by examining the price of a property over time as
environmental conditions change and correcting for all non-environmental factors,
information in the housing market can be used to estimate people's willingness to pay
for environmental quality.

The travel cost method is employed to measure the value of a recreational site by
surveying travelers on the economic costs they incur (e.g., time and out-of-pocket travel
expenses) when visiting the site from some distance away. These expenditures
are considered an indicator of society's willingness to pay for access to the
recreational benefits provided by the site.

Non-Market Methods. The Contingent Valuation Method (CVM) is a non-market-based

technique that elicits information concerning environmental preferences from individuals
through the use of surveys, questionnaires, and interviews. When deploying the
contingent valuation method, the examiner constructs a scenario or hypothetical market
involving an improvement or decline in environmental quality. The scenario is then posed
to a random sample of the population to estimate their willingness to pay (e.g., through
local property taxes or utility fees) for the improvement or their willingness to accept
monetary compensation for the decline in environmental quality. The questionnaire may

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take the form of a simple open-ended question (e.g., how much would you be willing to
pay) or may involve a bidding process (e.g., would you accept $10, would you accept
$20) or take-it-or-leave-it propositions. Based on survey responses, examiners
estimate the mean and median willingness to pay for an environmental improvement or
willingness to accept compensation for a decline in environmental quality.

Conclusion
Environmental valuation techniques are primarily driven by the principle that individuals
are self-interested and demonstrate preferences that form the basis of market interactions.
These market interactions demonstrate how individuals value environmental goods and
services. The market-based nature of economic theory emphasizes the maximization
of human welfare. The market, in turn, determines resource allocation based on the forces
of supply and demand.

The environment, thus, is used as an instrument to achieve human satisfaction. In turn,

the environment can be treated like any other commodity and its associated value can be
broken down into many elements. For example, the value of coastal areas could be
theoretically quantified based on the value of the products it offers (e.g., fish, crabs,
clams, recreation, and bird watching). In this manner, environmental valuation can be
viewed as a mechanistic approach in which the total value of an environmental system
is assessed in terms of the value of its individual parts.

Existence values are not demonstrated in the marketplace and are at least somewhat
based on unselfish motives making them problematic to environmental analysts. To
quantify existence values accurately within the framework of environmental valuation is
difficult. Revealed preference methods (e.g., travel cost method and hedonic
pricing methods) measure the demand for the environmental resource by measuring the
demand for associated market goods. Existence values are not adequately captured
using these methods. Existence values are only revealed through surveys of individual
willingness to pay for the environmental resource or willingness to accept
compensation for environmental losses.

THE FINANCIAL \ ECONOMIC ACCEPTANCE CRITERIA

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1) Net Present Value

(NPV): One project
accept if NPV >= 0

Many project (set of projects)

Most to least NPV values to rank
project choose until budget is
exhausted.

2) Benefit to Cost Ratio

(BCR) One project
accept if BCR >= 1

Many project (set of projects)

Most to least BCR values to rank
project choose until budget is
exhausted.

FORMAL DECISION TREE FOR ACCEPTING

PROJECTS (INDEPENDENT Vs.
DEPENDENT)
Decision State Constraint Criterion
of Depende
nce
Accept One Project NPV > 0
Accept One Maximize
of Several Projects
Accept few of NPV Independent Capital
many projects
Constraint Rank by BCR

No Capital Constraint Rank by NPV > 0

Dependent Capital Constraint Find feasible se

NPV given
your budget constr
No Capital Constraint Find possible se
maximize NPV (a
projects with
Zero
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