What Are The Two Key Capital Investment Techniques-winavi

UnCategorized If you plan to invest capital in premises, land or equipment you need to be able to work out the pros and cons of each investment opportunity. You can use capital investment techniques which estimate the in.e returns against all the outlays for the proposed investment over a period of time. This article summaries two types of capital investment techniques, the first type based on simple in.e estimates, and the second type based on discounted in.e estimates. Investment techniques based on simple in.e estimates The first kind based on simple in.e estimates .pares the forecast in.e over the life of the project to the original capital outlay. We’ll look at two investment techniques to do this. These are the Payback method and the average rate of return (ARR) method. Both are straightforward to use and hence very popular. Payback Method This technique calculates how long a project will take to pay for itself. To do this you estimate how much in.e will be generated per period over the life of the project and work out how long it takes for all the in.ing in.e to total all the capital outlay. If you are choosing between more than one project you might choose the project with the shortest payback time. Sometimes you can also allow for depreciation amounts taken from the in.e stream. So in this situation you would deduct from the in.e a depreciation amount per time period, so you are in effect reducing the capital value you need to recover over time. Average Rate of Return (ARR) method This technique calculates the percentage of total in.e generated over the total cost of the project. So the average rate of return (ARR) uses the same data as the Payback method but calculates the total in.e as a percentage of total capital costs. The number of time periods has no significance to the calculation, and again if you are choosing between more than one project you might choose the one with the highest ARR. Investment techniques based on discounted in.e estimates The second type of capital investment technique recognizes that the value of money reduces over time. For example if you spend 10 pounds on a particular kind of apple today you get 30 apples. If you wait a year and then buy the same 30 apples you find you have to pay 10 pounds 50. So 10 pounds50 in one year’s time is worth 10 pounds today, which is a reduction of 4.8%. So we can say the 10.50 is discounted by 4.8% to convert to today’s value. We’ll look at two investment techniques which use discounting to convert future in.e amounts to today’s values. These are Net Present Value (NPV) and Internal Rate of Return (IRR). Net Present Value (NPV) method This technique totals discounted future in.e generated by a project over its estimated life at fixed or different interest rates per period and deducts the total original capital investment to give a value of the worth of the project, the Net Present Value. The technique is very similar to the Payback method but uses discounted future in.es. A positive NPV indicates project is worth going ahead with and a negative NPV would suggest the reverse. Although more .plex than Payback, the NPV method more accurately reflects the time value of money. NPV can also allow for different discount rates for different periods and can be particularly relevant for times of high inflation rates. If you’re .paring more than one investment opportunity then you would tend to choose the one with the highest NPV. Internal Rate of Return, IRR This technique calculates the rate at which future in.e must be discounted back to the present day to equal the total original investment, so that the NPV is zero. In other words IRR is the discount rate which achieves a zero NPV for the project. The IRR rate can then be .pared, for example, with the rate to borrow the original capital. If the IRR is higher than the borrowing rate the project would be worth going ahead. So in this brief article we’ve described two different kinds of Capital Investment techniques. The first kind .pare total in.e streams to the original capital outlay, and the methods described were Payback and Average Rate of Return (ARR). Both are straightforward to use but do not take into account how money values changes over time. The second kind .pares discounted in.e streams to the original capital outlay, and the methods described were . Present Value (NPV) and Internal Rate of Return (IRR), both of which discount future money to today’s values. Interested in learning more about Capital Investment techniques? A really good way is to attend an instructor lead training course. The best ones can really widen your horizons. About the Author: 相关的主题文章: