Building a Business Case Investment evaluation and recommendation Payback

Building a business case investment evaluation and

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Building a Business Case Investment evaluation and recommendation Payback Period Analysis How long will it take for the returns to exceed the investment? Option A payback period = 10 years Option B payback period = 5 years Option B is more attractive because it returns profit sooner
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Building a Business Case Where t = evaluation period MARR = 5% t = 5 years
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Building a Business Case Investment evaluation and recommendation Net Present Value comparison Subtract discounted cash outflows from the discounted cash inflows NPV > 0 means the project is financially viable NPV (Option A) = -$46.5m NPV (Option B) = $18.5m Only option B is viable over a 5 year period
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Building a Business Case Investment evaluation and recommendation Internal Rate of Return comparison IRR represents the discount rate r at which NPV = 0 Invest only if IRR > MARR Over a 5 year period IRR (Option A) = -30.66% < MARR IRR (Option B) = 8.68% > MARR Only Option B is viable
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Building a Business Case Investment evaluation and recommendation Real Options Valuation – the next frontier Uncertainty changes with time but conventional evaluation methods do not account for this – static model of risk Flexibility to alter decisions in response to new information is valuable! Real Options Valuation allows us to quantify the value of managerial flexibility and incorporate this in the decision-making process Types of Real Options Simple options Defer the investment Expand the scope of investment Scale back the investment Abandon the investment Compound options Option to stage where value of option to start preceding stage depends on value of option to execute next stage Parallel options where two or more options are active at the same time
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