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112 Financial Management

Methods of Appraisal

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 known as discounting.

A. Non-Discounting Methods

l Urgency

l Payback Period

l Accounting Rate of Return

l Debt Service Coverage Ratio

B. Discounting Methods

l Net Present Value

l Profitability Index

l Internal Rate of Return

C. Economic Value Added (EVA) charm 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.

Chapter-5

Capital Budgeting Evaluation Techniques