SEMI-FINAL TOPICS

I. Project Assessment/ Project Evaluation

Project evaluation is a process of measuring the success of a project, program or portfolio. It
involves determining how well a project is meeting its goals and objectives. The evaluation helps
determine if a project is worth continuing, needs adjustments, or should be discontinued.

Criteria in assessing the project evaluation:

1. Net present value (NPV)
-is a financial metric used to evaluate the profitability of a project. It is calculated
by subtracting the initial investment from the present value of all future cash flows
generated by the project. This calculation helps to determine the overall profitability of the
project and whether it is worth investing in.
-is a useful tool for evaluating projects because it takes into account the time value of
money. This means that it takes into account the fact that money today is worth more than money
in the future.

Formula:
NPV = [cash flow / (1+r) ^t] - initial investment
If NPV is greater than 0 = project accepted
If NPV is less than 0 = project rejected

Example #1:
Delacruz Company .is planning a 5 year project with an initial investment of 500,000 pesos. The
company projects the investment to generate a cash flow of Php 25,000 on the first year, 40,000 on the
second year and 50,000, 30,000 and 100,000 respectively for the next succeeding years. The NPV assumes
that the required rate of return is 6%. Calculate whether the project is rejected or accepted.

Solution:
25,000 + 40,000 + 50,000 + 30,000 + 100,000 - 500,000
1.06^1 1.06^2 1.06^3 1.06^4 1.06^5

23,584.91 + 35, 599.86 + 41, 980.96 + 23, 762.81 + 74,725.82 – 500,000

= 199,654.36- 500,000
= (300, 345.64)

This NPV shows that the project is less than 0, so the managers can reject it.

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Example #2:
Compute the following data using NPV method.

Discount rate 5%
Initial Investment 500,000
Year 1 50,000
Year 2 75,000
Year 3 100.000
Year 4 150,000
Year 5 250,000
NPV ?

Solution:
50,000 + 75,000 + 100,000 + 150,000 + 250,000 - 500,000
1.06^1 1.06^2 1.06^3 1.06^4 1.06^5

2. Benefit cost ratio

The benefit-cost ratio (BCR) is a ratio used in a cost-benefit analysis to summarize the
overall relationship between the relative costs and benefits of a proposed project.

Formula:

BCR = BENEFITS
COST

OR

Where:

 CF = Cash flow
 i = Discount rate
 n = Number of periods
 t = Period that the cash flow occurs

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 Example #1:

Cash flow projections for a project are provided below. The relevant discount rate is 10%.

Question: What is the benefit-cost ratio of the project?

Answer:

The benefit-cost ratio would be calculated as 97,670.72 / 33,625.09 = 2.90.

Interpreting the Benefit-Cost Ratio

The higher the BCR, the more attractive the risk-return profile of the project/asset. The value generated by the
BCR indicates the dollar value generated per dollar cost.

The BCR of 2.90 in the preceding example can be interpreted as “For each $1 of cost in the project, the
expected dollar benefits generated is $2.90.”

Example #2:
As an example, assume company ABC wishes to assess the profitability of a project that
involves renovating an apartment building over the next year. The company decides to lease the equipment
needed for the project for Php 50,000 rather than purchasing it. The inflation rate is 2%, and the renovations
are expected to increase the company; s annual profit by Php100, 000 for the next three years.

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The NPV of the total cost of the lease does not need to be discounted, because the initial cost of Php50, 000 is
paid up front. The NPV of the projected benefits is:

Formula:
100,000 + 100,000 + 100,000 / 50,000
1.02^1 1.02^2 1.02^3
=288, 388/ 50, 000
BCR= 5.77

Interpretations:
In this example, our company has a BCR of 5.77, which indicates that the project is estimated benefits
significantly outweigh its costs. Moreover, company ABC could expect Php 5.77 in benefits for each Php 1 of
costs.

1. IRR (Internal Rate of Return)

IRR, or internal rate of return, is a way of evaluating a project and coming up with a
decision to accept or reject that project. IRR is a discount rate that makes the net present value (NPV) of all
cash flows equal to zero in a discounted cash flow analysis. IRR calculations rely on the same formula as NPV
does. Keep in mind that IRR is not the actual peso value of the project. It is the annual return that makes the
NPV equal to zero. In general, when comparing investment options with other similar characteristics, the
investment with the highest IRR probably would be considered the best.

Formula:
NPV = [cash flow / (1+r) ^t] - initial investment
NPV must equal to zero; in order to be equal to zero we must do a trial and error, and pick an
interest rate that would make the NPV equal to zero.

Example #1
Assuming we have a one-year timeline project. Now, we have an investment of Php 100,000 and at the
end of year 1 were going to receive a cash of Php 130,000 with an interest rate of 8%.

Solution:
NPV = [cash flow / (1+r) ^t] - initial investment
-100,000 + 130,000
1.08^1
NPV = 20.37
Let’s try to choose 30%
-100,000 + 130,000
1.30^1
NPV = 0

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Example #2

A company is deciding whether to purchase new equipment that costs Php 500,000. Management estimates the
life of the new asset to be five years and expects it to generate an additional Php160, 000 of annual profits, with
an interest rate of 8%.

To make a decision, the IRR for investing in the new equipment is calculated below.

Discount rate 8% Discount rate 10%

Initial Investment 500,000 Initial Investment 500,000
Year 1 160,000 Year 1 160,000
Year 2 160,000 Year 2 160,000
Year 3 160.000 Year 3 160.000
Year 4 160,000 Year 4 160,000
Year 5 160,000 Year 5 160,000
NPV ? NPV ?

Discount rate 13%

Initial Investment 500,000
Year 1 160,000
Year 2 160,000
Year 3 160.000
Year 4 160,000
Year 5 160,000
NPV ?

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