Propuesta de mejora en la implementación del SG-SST en la empresa

Several methods of evaluating investment projects are as follows:

1. Payback period

2. Accounting rate of return (ARR) 3. Internal rate of return (IRR)

189 4. Net present value (NPV)

5. Profitability index (or present value index)

The NPV method and the IRR method are called discounted cash flow (DCF) methods. Each of these methods is discussed below.

Payback Period

The payback period measures the length of time required to recover the amount of initial investment. It is computed by dividing the initial investment by the cash inflows through increased revenues or cost savings.

Initial investment Payback period =

Annual Cash Inflows

EXAMPLE 8

Assume:

Cost of investment $18,000 Annual cash savings $3,000

Then, the payback period is:

Initial investment $18,000

Payback period = = = 6 years Cost savings $3,000

Decision rule: Choose the project with the shorter payback period. The rationale behind this choice is: The shorter the payback period, the less risky the project, and the greater the liquidity.

EXAMPLE 9

Consider the two projects whose after-tax cash inflows are not even. Assume each project costs $1,000.

190 Cash Inflow Year A($) B($) 1 100 500 2 200 400 3 300 300 4 400 100 5 500 6 600

When cash inflows are not even, the payback period has to be found by trial and error. The payback period of project A is 4 years ($1,000= $100 + $200 + $300 + $400). The payback period of project B is 2 1/3 years ($1,000 = $500 + $400 + $100):

$100

2 years + = 2 1/3 years $300

Project B is the project of choice in this case, since it has the shorter payback period.

The advantages of using the payback period method of evaluating an investment project are that (1) it is simple to compute and easy to understand, and (2) it handles investment risk effectively.

The shortcomings of this method are that (1) it does not recognize the time value of money, and (2) it ignores the impact of cash inflows received after the payback period; essentially, cash flows after the payback period determine profitability of an investment.

Accounting Rate of Return

Accounting rate of return (ARR), also called simple or unadjusted rate of return, measures profitability from the conventional accounting standpoint by relating the required initial investment (I) -- or sometimes the average investment--to the future average annual income.

ARR = Investment Average) (or Initial Income Annual Average s Project'

191 Average investment = 2 S) - I ( + S or simply 2 I if S = 0

where I = initial (original) investment and S = salvage value.

Decision rule: Under the ARR method, choose the project with the higher rate of return.

EXAMPLE 10

Consider the following investment:

Initial investment (I) $6,500 Estimated life 20 years Cash inflows per year $1,000 Depreciation per year (using straight line) $325

Salvage value (S) 0

The accounting rate of return for this project is:

Average income $1,000 - $325

ARR = = = 10.4% Investment $6,500

If average investment is used, then:

$1,000 - $325 $675

ARR = = = 20.8% $6,500/2 $3,250

The advantages of this method are that it is easily understood, simple to compute, and recognizes the profitability factor.

The shortcomings of this method are that it fails to recognize the time value of money, and it uses accounting data instead of cash flow data.

192

Internal Rate of Return

Internal rate of return (IRR), also called time adjusted rate of return, is defined as the rate of interest that equates I with the PV of future cash inflows.

In other words,

at IRR, I = PV

(or NPV = 0)

Decision rule: Accept the project if the IRR exceeds the cost of capital. Otherwise, reject it.

EXAMPLE 11

Consider the following investment:

Initial investment $12,950 Estimated life 10 years Annual cash inflows $3,000 Cost of capital (minimum required rate of return) 12%

We set the following equality (I = PV):

$12,950 = $3,000 · T4(i,10 years)

$12,950

T4(i,10 years) = = 4.317 $3,000

which stands somewhere between 18 percent and 20 percent in the 10-year line of Table 4. The interpolation follows: PV of An Annuity of $1 Factor T4(i,10 years) 18% 4.494 4.494 IRR 4.317 20% 4.192 Difference 0.177 0.302

193 Therefore, 0.177 IRR = 18% + (20% - 18%) 0.302 = 18% + 0.586(2%) = 18% + 1.17% = 19.17%

Since the IRR of the investment is greater than the cost of capital (12 percent), accept the project.

The advantage of using the IRR method is that it does consider the time value of money and, therefore, is more exact and realistic than the ARR method.

The shortcomings of this method are that (1) it is time-consuming to compute, especially when the cash inflows are not even, although most financial calculators and PCs have a key to calculate IRR, and (2) it fails to recognize the varying sizes of investment in competing projects.

Net Present Value

Net present value (NPV) is the difference between the present value (PV) of the cash inflows and the initial investment (I) associated with a project:

NPV = PV – I

The present value of future cash flows is computed using the so-called cost of capital (or

minimum required rate of return) as the discount rate. When cash inflows are uniform, the present value would be

PV = A . T4 (i, n)

where A is the amount of the annuity. The value of T4 is found in Table 4 of the Appendix.

Decision rule: If NPV is positive, accept the project. Otherwise reject it.

EXAMPLE 12

194 PV = A · T4(i,n)

= $3,000 · T4(12%,10 years)

= $3,000 (5.650) $16,950 Initial investment (I) 12,950 Net present value (NPV = PV - I) $4,000

Since the NPV of the investment is positive, the investment should be accepted.

The advantages of the NPV method are that it obviously recognizes the time value of money and it is easy to compute whether the cash flows form an annuity or vary from period to period.