Project Selection Ratios 

Financial evaluation techniques help determine whether a project creates economic value. This is highly important becuase the main reson for project failure is the absense of solid business case. 

Key concepts include; Time Value of Money, Compounding, Net Present Value (NPV), Internal Rate of Return (IRR), and Benefit-Cost Ratio (BCR).

These concepts will help us to choose the best projects for execution. 

1. Time Value of Money (TVM)

Time Value of Money means that money available today is worth more than the same amount in the future.

Reasons:

• Money today can earn interest

• Inflation reduces future purchasing power

• Risk and uncertainty

Example

If you have ₹10,000 today and invest it at 10% interest, after one year it becomes:

₹10,000 × 1.10 = ₹11,000

So ₹10,000 today = ₹11,000 after one year at 10% interest.

Key PMP Insight

Financial evaluation techniques like Net Present Value, Internal Rate of Return, and Benefit-Cost Ratio are based on the concept of Time Value of Money.

2. Compounding

Compounding is the process where interest earned also starts earning interest.

Formula

Future Value (FV)

FV = PV (1+r)^n

Where:

• PV = Present value

• r = interest rate

• n = number of years
  
  

Example

• • • Investment = ₹10,000

    • Interest = 10%

    • Years = 3

    • FV = 10000(1.10)^3

    • FV = 10000 × 1.331 = 13,310

    • After 3 years → ₹13,310

3. Net Present Value (NPV)

The Net Present Value is the difference between the present value of benefits and the present value of costs.

Formula

NPV = Sum of the Present Value of Future Benefits - Initial Investment 

Example

Project Investment = ₹100,000

Expected returns (Future Values);

Year#1  40,000

Year#2 50,000

Year#3 30,000

Rate of Interest or Discount rate = 10%

Present values:

Year 1 = 40,000 / 1.1 = 36,364

Year 2 = 50,000 / 1.21 = 41,322

Year 3 = 30,000 / 1.331 = 22,540

Total PV of benefits = ₹100,226

NPV: Present value of benefits - Initial investment 

100,226 − 100,000 = ₹226

Decision Rule

• NPV > 0 → Accept project

• NPV = 0 → Neutral

• NPV < 0 → Reject project

4. Internal Rate of Return (IRR)

The Internal Rate of Return is the discount rate at which NPV becomes zero.

NPV = 0

Meaning:

Present value of inflows (benefits) = Investment

Example

If a project has:

Investment = ₹100,000

Future benefits discounted at 15% give NPV = 0

Then:

IRR = 15%

Decision Rule

Accept project if:

IRR > Cost of Capital

Example:

• Cost of capital = 10%

• IRR = 15%
  
  

5. Benefit-Cost Ratio (BCR)

The Benefit-Cost Ratio compares present value of benefits to present value of costs.

Formula

BCR = Present Value Of Benefits / Present Value Of Costs 

Example

PV of benefits = ₹150,000

PV of costs = ₹100,000

BCR = 150000 / 100000 = 1.5

Decision Rule

• BCR > 1 → Accept

• BCR = 1 → Neutral

• BCR < 1 → Reject
  
  

Complete the quiz below