22/03/2024

Project Financial
Analysis

Created by

Tariq Malik

Performing Financial Projections

Financial considerations are often an

important aspect of the project
selection process
Three important methods include:
Net present value analysis
Return on investment
Payback analysis

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3 Payback Rule
Payback period: The amount of time it
takes to recover the original cost.

Payback rule: If the calculated payback

period is less than or equal to some pre-
specified payback period, then accept the
project. Otherwise reject it.

Even Cash Flow

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A Company is planning to undertake a
project requiring initial investment of
$105 million. The project is expected to
generate $25 million per year in net
cash flows for 7 years. Calculate the
payback period of the project.
Payback Period
= Initial Investment ÷ Annual Cash Flow
= $105M ÷ $25M
= 4.2 years
Tariq Malik UCP Business School Spring 2020

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The Payback Rule - Example

Cash Flow
$200 $220 $225 $210

Time
0 1 2 3 4

$-600
Project Period = 4 Years
Accept , if Payback the is less than 4 years
Reject , if Payback the is more than 4 years
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Uneven Cash Flows

6 Period Cash Flow Cumulative CF
0 -600 -600
1 200 -400
2 220 -180
3 225 45
4 210 255
5 420 675

Payback Period = A + B/C

Payback Period = 2 + (180/225)
Payback Period = 2.8
where
A Year with last negative value of CCF
B Absolute Value of Cumulative Net Cah Flow at the end of Period A
C Total Cash Inflow during the period following A
Tariq Malik UCP Business School Spring 2020

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7 Present value

The amount of money you must invest or

lend at the present time so as to end up
with a particular amount of money in the
future.

Tariq Malik UCP Business School Spring 2020

Net Present Value Analysis

Net present value (NPV) analysis is a
method of calculating the expected net
monetary gain or loss from a project by
discounting all expected future cash
inflows and outflows to the present point
in time
NPV means the return from a project
exceeds the opportunity cost of capital—
the return available by investing the
capital elsewhere
Projects with higher NPVs are preferred to
projects with lower NPVs if all other
factors are equal
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Project Appraisal Methods
Net Present Value (NPV)
Net Present Value (NPV) is the difference
between the present values of cash
inflows and outflows of an investment

Opportunity cost of undertaking the

investment is the alternative of earning
interest rate in the financial market.

10 Net Present Value (NPV) Rule



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NPV
11 Suppose you setup a factory with initial
investment of
£ 250,000.00 & it returns annual income as
Period Investment (Cash Outflow) Cash Inflow
detailed below:
2019-A 0 -£250,000.00
2020-P 1 £100,000.00
2021-P 2 £150,000.00
2022-P 3 £200,000.00
2023-P 4 £250,000.00
2024-P 5 £300,000.00
Tariq Malik UCP Business School Spring 2020

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Future Value = Present Value *(1+r)t

12 Present Value = Future Value/(1+r)t
r = discount rate
t = number of periods
Future Value of £100 with a discount
rate of 10% is:
FV = 100 * (1+.1)1
FV = 100 * 1.1 = 110

NPV = CF0/(1+r)0+CF1/(1+r)1+CF2/(1+r)2+ ...

Tariq Malik UCP Business School Spring 2020

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NPV = CF0/(1+r)0+CF1/(1+r)1+CF2/(1+r)2+………………….
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Discounted Cash
Flow
Perio Investment (Cash Cash PV =
10%
d Outflow) Inflow D26/((1+$B$25)^C26)
2019-A 0 -£250,000.00 -£250,000.00
£100,000.
1 £90,909.09
2020-P 00
£150,000.
2 £123,966.94
2021-P 00
£200,000.
3 £150,262.96
2022-P 00
£250,000.
4 £170,753.36
2023-P Tariq Malik UCP Business School Spring 2020
00
£300,000.
5 £186,276.40
2024-P 00
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Figure 2-4. Net Present Value Example

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Figure 2-5. Detailed NPV Calculations

Discount rate 10%

Year
PROJECT 1 1 2 3 4 5 Total
Benefits $ - $ 2,000,000 $ 2,000,000 $ 2,000,000 $ 2,000,000 $ 8,000,000
Discount factor 0.91 0.83 0.75 0.68 0.62
Discounted benefits $ - $ 1,652,893 $ 1,502,630 $ 1,366,027 $ 1,241,843 $ 5,763,392
Costs $ 4,000,000 $ 500,000 $ 500,000 $ 500,000 $ 500,000 $ 6,000,000
Discount factor 0.91 0.83 0.75 0.68 0.62
Discounted costs $ 3,636,364 $ 413,223 $ 375,657 $ 341,507 $ 310,461 $ 5,077,212

Total discounted benefits - costs, or NPV $ 686,180

Note: The discount factors are not rounded to two decimal places.
They are calculated using the formula discount factor =1/(1+discount rate)^year.

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NPV Considerations
Some organizations refer to the investment
year(s) for project costs as Year 0 instead
of Year 1 and do not discount costs in
Year 0
The discount rate can vary, based on the
prime rate and other economic
considerations.
You can enter costs as negative numbers
instead of positive numbers, and you can
list costs before benefits
Project managers should check to see
which approaches their organizations
prefer when calculating NPV
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Figure 2-6. Intranet Project NPV Example

Schwalbe, Information Technology Project Management, Sixth Edition, 2010

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Steps for Calculating NPV

1. Determine the estimated costs and benefits
for the life of the project and the products it
produces.
2. Determine the discount rate. A discount rate
is the rate used in discounting future cash
flows. The annual discount factor is a multiplier
for each year based on the discount rate and
year (calculated as 1/(1+r)t, where r is the
discount rate, and t is the year).
3. Calculate the net present value by
subtracting the total discounted costs from
the total discounted benefits.

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Return on Investment
Return on investment (ROI) is the result of
subtracting the project costs from the benefits
and then dividing by the costs.
For example, if you invest $100 today and next
year your investment is worth $110, your ROI is
($110 – 100)/100, or 0.10 (10 percent)
Note that the ROI is always a percentage, and
the higher the ROI, the better
Many organizations have a required rate of return
for projects—the minimum acceptable rate of
return on an investment
You can find the internal rate of return (IRR) by
finding what discount rate results in an NPV of
zero for the project
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Payback Analysis
Payback period is the amount of time it will
take to recoup—in the form of net cash
inflows—the total dollars invested in a
project
Payback analysis determines how much
time will lapse before accrued benefits
overtake accrued and continuing costs
Payback occurs in the year when the
cumulative benefits minus costs reach zero
The shorter the payback period, the better

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Figure 2-7. Charting the Payback Period

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What is Internal Rate of Return (IRR)?

22 is the interest rate at which the net present
value (NPV) of all the cash flows (both
positive and negative) from a project or
investment equal zero.
Internal rate of return is used to evaluate
the attractiveness of a project
or investment.
If the IRR of a new project exceeds a
company’s required rate of return, that
project is desirable. If IRR falls below the
required rate of return, the project should
be rejected

Tariq Malik UCP Business School Spring 2020

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23 Let us assume that Nick invests £1,000 in a project

A and gets a return of £1400 in 1 years
time. Calculate Internal Rate of Return of project
A?

Tariq Malik UCP Business School Spring 2020

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From the graph below, we note that the Net Present

24 value is zero at the discount rate of 40%. This discount
rate of 40% is the Internal rate of return of the project.

Tariq Malik UCP Business School Spring 2020

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25  rateWhat Does
of growth IRR Tell
a project You? to generate.
is expected
While the actual rate of return that a given project
ends up generating will often differ from its
estimated IRR, a project with a substantially higher
IRR value than other available options would still
provide a much better chance of strong growth.
 One popular use of IRR is comparing the profitability
of establishing new operations with that of
expanding existing ones. For example, an energy
company may use IRR in deciding whether to open
a new power plant or to renovate and expand a
previously existing one. While both projects are likely
to add value to the company, it is likely that one will
be the more logical decision as prescribed by IRR.

Tariq Malik UCP Business School Spring 2020

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26 Internal Rate of Return (IRR) Rule

IRR is a yield – what we earn, on average,
per year. Compare the IRR to the required
(risk-adjusted) rate of return
If IRR > required risk-adjusted return
 Accept project
If IRR = required risk-adjusted return
 Indifference
If IRR < required risk-adjusted return
 Reject project
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Example

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Example

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Example

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Example

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Example

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Example

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Example

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Example

Projec NPV @ 9% IRR Remarks

t
$ 0.000 9.00 %
A Lowest Lowest
Rejected

$ 18,897 Accepted
B Highest
42.78 % on NPV
Accepted
C $ 17,969 55.74 %
Highest on IRR
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Example

Projec NPV @ 9% IRR Remarks

t
$ 0.000 9.00 %
A Lowest Lowest
Rejected

$ 18,897 Accepted
B Highest
42.78 % on NPV
Accepted
C $ 17,969 55.74 %
Highest on IRR
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Example

Projec NPV @ 9% IRR Remarks

t
$ 0.000 9.00 %
A Lowest Lowest
Rejected

$ 18,897 Accepted
B Highest
42.78 % on NPV
Accepted
C $ 17,969 55.74 %
Highest on IRR
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Example

Projec NPV @ 9% IRR Remarks

t
$ 0.000 9.00 %
A Lowest Lowest
Rejected

$ 18,897 Accepted
B Highest
42.78 % on NPV
Accepted
C $ 17,969 55.74 %
Highest on IRR
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NPV & IRR Example

During the project appraisal study, it found that a project offered to your company
has its Internal Rate of Return (IRR) is 35% and is expected to generate a net
cash flow of Rs.450,000 per year for next 5 years and it is going to start with an
initial investment of Rs. 1,250,000. Justify by giving calculations whether it is
feasible or not.

Yr Cash Flow Discount Factor Discounted Cash Flow

0
0 -1,250,000 1÷(1+35%) = 1÷1.0000 = 1.0000 1.00 x -1,250,000 = (1,250,000.00)
1
1 450,000 1÷(1+35%) = 1÷1.3500 = 0.7407 0.7407 x 450,000 = 333,333.33
2
2 450,000 1÷(1+35%) = 1÷1.8225 = 0.5487 0.5487 x 450,000 = 246,913.58
3
3 450,000 1÷(1+35%) = 1÷2.4604 = 0.4064 0.4064 x 450,000 = 182,898.95
4
4 450,000 1÷(1+35%) = 1÷3.3215 = 0.3011 0.3011 x 450,000 = 135,480.70
5
5 450,000 1÷(1+35%) = 1÷4.4840 = 0.2230 0.2230 x 450,000 = 100,356.08
Net Present Value =
Rs. (251,017)

NPV is negative – Project is not feasible

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Template Files Available

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A template file called payback period

chart is provided on the companion Web
site for this text (www.intropm.com) as well
as one for calculating NPV, ROI, and
payback for a project (called business
case financials)
See Appendix B for a list of all template
files

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Weighted Scoring Models

 A weighted scoring model is a tool that provides a
systematic process for selecting projects based on many
criteria
 To create a weighted scoring model:
Identify criteria important to the project selection
process
Assign a weight to each criterion (so they add up to
100 percent)
Assign numerical scores to each criterion for each
project
Calculate the weighted scores by multiplying the
weight for each criterion by its score and adding the
resulting values

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Figure 2-8. Sample Weighted Scoring

Model for Project Selection
Criteria Weight Trip 1 Trip 2 Trip 3 Trip 4
Total cost of the trip 25% 60 80 90 20
Probability of good weather 30% 80 60 90 70
Fun activities nearby 15% 70 30 50 90
Recommendations 30% 50 50 60 90
Weighted Project Scores 100% 64.5 57.5 75 66.5

Weighted Score by Project

Trip 4

Trip 3

Trip 2

Trip 1

0 20 40 60 80
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