Investment Evaluation Criteria

Three steps are involved in the evaluation of an investment:

• Estimation of s

• Estimation of the required rate of return (the cast of capital)

• Application of a decision rule for decision rule for making the choice

Investment decision rule

The investment decision may be referred to as capital budgeting techniques, or investment criteria. A sound appraisal technique should be used to measure the economic worth of an investment project. The essenl property of a sound technique is that is should maximize the shareholders wealth. The following other characteristics should also be possessed by a sound investment evaluation criterion:

• It should consider all s to determine the true ability of then project.

• It should for an objective and unambiguous way of separate good projects from bad projects.

• It should help ranking of projects according to their true ability.

• It should recognize the fact that bigger s are prefer to smaller ones and early s are prefer to later ones.

• It should help to choose among mutually exclusive projects that project which maximizes the shareholders wealth.

• It should be a criterion which is applic to any conceiv investment project independent of others.

These conditions will be clarified as we discuss the fures of various investment criteria in the following posts.

Investment Appraisal Criteria

A number of investment appraisal criteria or capital budgeting techniques are in use of practice. They may be grouped in the following two categories:

1. Discounted criteria

• Net pre value

• Internal rate of return

ability index (PI)

2. discounted criteria

• Payback period

• Accounting rate of return

• Discounted payback period

Discounted payback is a variation of the payback method. It involves discounted method, but it is a true measure of investment ability. We will show in our following posts the net pre value criterion is the most valid technique of evaluating an investment project. It is consistent with the objective of maximizing the shareholders wealth.

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