VILNIAUS GEDIMINO TECHNIKOS UNIVERSITETAS

                                                 

                         

                                         

                                 

             VALUATION OF CAPITAL INVESTMENT PROJECTS

                                                                     Prepared by: JATIN PATEL

                                                                         Checked by: doc v filipavicius

Index: -

 Introduction……………………………………………………………………… 3

1) Project valuation overview

   1.1) need for valuation of project……………………………………………4

   1.2) valuation of cost of project……………………………………………..4

   1.3) cash flow and its variation……………………………………………...6

     1.3.1) effect of inflation of cash flow……………………………………...7

     1.3.2) effect of different depreciation method on cash flow………….7

2) Methods of project valuation……………………………………………….8

   2.1) net present value calculation…………………………………………..8

   2.1.1) benefits and limitation of net present value method…………..12

2.2) rate of return analyses

 2.2.1) internal rate of return………………………………………………….12

 2.2.2) benefits and limitation of internal rate of return…………………14

 2.2.3) modified internal rate of return……………………………………...14

2.3) payback analyses

 2.3.1) payback period……………………………………………………….....15

 2.3.2) discounted payback period……………….…………………………..15

 2.3.3) advantage of payback period………………………………………...16

 2.3.4) limitation of payback period…………………………………………..16

2.4) total cost of ownership…………………………………………………...17

  2.4.1) benefits and limitation of TCO……………………………………….19

2.5) return on investment………………………………………………………20

  2.5.1) benefits of return on investment…………………………………….22

  2.5.2) limitation of return on investment…………………………………..22

Conclusion……………………………………………………………………….23

INTRODUCTION: -

                All organizations, big or small, with limited resources or unlimited resources. The ever increasing demand for the share holders keeps increasing pressure on these resources, physical or intangible. This in turn force the management to make rational decision when they are making investment in resources and leading to needs the valuation of the project.

                 For the valuation the company needs to make paper work. The paper consists of three parts. The first part is committed to identify the need of the project, determine the role value of money, inflation depreciation in evaluation process. The second paper consists of basic theoretical investment valuation methods and its benefits and limitation. Finally the last paper indicates the introduction with different concept of the project analyses. This part explains how project analyses is conducted using the technique such as sensitivity analyses, scenario and break even analyses, and Monte Carlo stimulation.

                This paper is needed to shows the primary outlines of the project valuation analyses. It is like collection of methodological and theoretical description of valuation which is mostly applied in the company’s capital investment. This paper examines the valuation of risky projects in a setting where the investor’s probability estimates for future states of nature are ambiguous and where he or she can invest both in a portfolio of projects and securities in financial markets. This setting is relevant to investors who

Allocate resources to industrial research and development projects or

Make venture capital investments whose success probabilities may be

Hard to estimate. Here, we employ the Coquet-Expected Utility (CEU)

Model to capture the ambiguity in probability estimates and the investor’s

Attitude towards ambiguity. Projects are valued using breakeven selling

And buying prices, which are obtained by solving several mixed asset

Portfolio selection models. Specifically, we formulate the MAPS

Model for CEU investors, and show that a project’s breakeven prices for

Investors exhibiting constant absolute risk aversion and for

Investors using Wald’s maximum criterion can be obtained by solving two

MAPS problems. We also show that breakeven prices are consistent with

Options pricing analysis when the investor is a non-expected utility

Maximize. The valuation procedure is demonstrated through numerical

Experiments.

  1. Project valuation overview.
  1. Need for valuation of project.

                       

           Each companies, either small entrepreneurship or international corporation, needs to know about the specific investment direction. In order then it requires specific funds for investment, it would select the proper project for the investment.

                 Economic valuation makes the company or project empowers to make such decision on the measure of the project and economical-financial profit of the particular project. It could define the particular goal of the valuation of investment project.

 

  • To guarantee that risk for the company and project exercised is minimized.
  • To lay the foundation for future analysis of investment project application.

Investment project valuation analyses the basic contains of the project such as economic and financial profit from each engineering project, identifying the risk level, possibilities of accident for each projects and expected profit and costs.

          Project valuation not only assists managers to make the right              decision but also settles the priority and succession of the expected projects.

1.2. Valuation of cost of project.

 

        Cost basis is the original price of an asset, such as stocks, bonds, mutual funds, property, or equipment. Cost basis includes the purchase price and any associated purchase costs.

Additional purchase costs included in cost basis are shipping, sales tax, installation costs, commissions and fees on the purchase, and certain tax-related adjustments. Cost basis may increase or decrease because of tax-deferred gains or tax-deferred losses. Cost basis forms the foundation for calculating adjusted basis, capital gains, capital losses, and depreciation.

         In economic terms whether theoretically or practically there are cost classification models, where in valuation of project there are the most commonly cost used are: -

  • Initial cost: - initial cost refers to the cost originated at the beginning of the project. Examples of initial research are installation of machinery and equipments. And to make interior for the shop. Cost arises at the beginning of science research.

  • Production costs: - The production cost arises after the project starts. Examples of the production costs are salary of employee, ware house cost, maintain cost, and production cost.
  • Life cycle cost: - This cost is arises till the end of the project.
  • Variable and fixed cost: - Variable costs are costs that can be varied flexibly as conditions change. Labor costs are the variable costs. Fixed costs are the costs of the investment goods used by the firm, on the idea that these reflect a long-term commitment that can be recovered only by wearing them out in the production of goods and services for sale.
  • Marginal cost: - In economics and finance, marginal cost is the change in total cost that arises when the quantity produced changes by one unit. Mathematically, the marginal cost (MC) function is expressed as the derivative of the total cost (TC) function with respect to quantity (Q). Note that the marginal cost may change with volume, and so at each level of production, the marginal cost is the cost of the next unit produced.
  • Total and average cost: - In economics, average cost is equal to total cost divided by the number of goods produced (the output quantity, Q). It is also equal to the sum of average variable costs (total variable cost divided by Q) plus average fixed costs (total fixed cost divided by Q). Average costs may be dependent on the time period considered (increasing production may be expensive or impossible in the short term, for example). Average costs affect the supply curve and are a fundamental component of supply and demand.

  • Direct and indirect cost: - Direct costs are those for activities or services that benefit specific projects, e.g., salaries for project staff and materials required for a particular project. Because these activities are easily traced to projects, their costs are usually charged to projects on an item-by-item basis.

Indirect costs are those for activities or services that benefit more than one project. Their precise benefits to a specific project are often difficult or impossible to trace. For example, it may be difficult to determine precisely how the activities of the director of an organization benefit a specific project.

Valuation of the project depends on the costs and profits. Therefore it’s very important to have such specified costs and saved funds/resources. Which can be classified as: -

  •  Cost of tangible assets.
  • Income earn from assets sold.
  • Fixed and variable cost reduction.

 1.3. Cash flows and its variation: -

        In economic terms valuation of project is depends on the future cash flow. The cash flow shows the cost and income from the project. Therefore its necessary to calculate cash flow for the future five years.

           In financial accounting, a cash flow statement or statement of cash flows is a financial statement that shows a company's flow of cash. The money coming into the business is called cash inflow, and money going out from the business is called cash outflow. The statement shows how changes in balance sheet and income accounts affect cash and cash equivalents, and breaks the analysis down to operating, investing, and financing activities. As an analytical tool, the statement of cash flows is useful in determining the short-term viability of a company, particularly its ability to pay bills. International Accounting Standard 7 (IAS 7) is the international accounting standard that deals with cash flow statements.

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        The cash flow statement was previously known as the statement of changes in financial position or flow of funds statement. The cash flow statement reflects a firm's liquidity or solvency.

The balance sheet is a snapshot of a firm's financial resources and obligations at a single point in time, and the income statement summarizes a firm's financial transactions over an interval of time. These two financial statements reflect the accrual basis accounting used by firms to match revenues with the expenses associated with generating those revenues. The cash flow statement includes only inflows and outflows of cash and cash equivalents; ...

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