Project appraisal methodologies are used to provide a structured assessment of the potential value and viability of projects. Businesses use these methodologies when they are considering multiple projects to evaluate and prioritize their investment in new projects.
Payback is a calculation of the amount of time needed to recover the cost of the project through savings or increased revenues. It is a relatively simple way of assessing the value of a project and comparing it with similar projects. However, it does not demonstrate the financial benefit of the project to the company -- only the time it takes to pay for itself. Also, payback does not reflect the fact that a dollar today is worth more than one in the future, not only because of the effect of inflation but also because it can be invested and earn interest.
Net Present Value
Net present value takes the amount invested today and the value of revenue or savings achieveable in the future to calculate the value of the project at today's prices. Future returns are discounted to reflect the effect of inflation or the cost of capital required to fund the project. There is no standard discount rate applied to every type of project; the rate used depends on the particular investment costs and demands of the business.
Internal Rate of Return
Internal rate of return demonstrates the return on a project or investment as a percentage figure. Like net present value, IRR discounts future cash flows. However, rather than applying a standard discount rate to the project, the discount rate is calculated as the figure required to make the net present value zero. Using this methodology allows the business to compare the rates of return expected across a range of different projects and against the rate of return achievable from other investments, such as leaving the money in the bank.
Cost Benefit Analysis
Cost benefit analysis is typically applied to large infrastructure and public projects, although it can also be relevant to businesses if they are working within a consortium delivering a major project. CBA uses discounted cash flow techniques and applies them to an assessment of the social and economic benefits of a project. It typically requires complex assessment of the impact of the project, for example the number of journeys and the journey time saved from the development of a new highway in addition to the increase in access to new opportunities for local business through the improved transportation link. Each benefit is monetized to provide a common dollar value and future values discounted over time.
Based near London, Nick Mellors has been published in various journals from “Outsource Magazine” to the Association of Council Secretaries and Solicitors’ “A Passion for Leadership & Going Beyond Austerity." He is a Chartered IT Professional and holds an MBA and CIM diploma in marketing.