Tuesday, October 12, 2010


Project Evaluation

The evaluation of projects should be performed by a group of experts who have no axe to grind. For example, the production people may generally interested in having the most modern type of equipments and increased production even if productivity is expected to be low and goods cannot be sold. This attitude can bias their estimates of cash flows of the proposed projects. Similarly, marketing executives may be too optimistic about the sales prospects of goods manufactures and overestimate the benefits of a proposed new product. It is, therefore, necessary to ensure that projects are scrutinized by an impartial group and that objectivity is maintained in the evaluation process.

A company in practice should take all care in selecting a method or methods of investment evaluation. The criterion selected should a true measure of the investments profitability (in terms of cash flows), and it should lead to the net increase in the companies wealth (that is, its benefits should exceed its cost adjusted for time value and risk). It should also be seen that the evaluation criteria do not discriminate between the investment proposals. They should be capable of ranking projects correctly in terms of profitability. The net present value method is theoretically most desirable criterion as it is a true measure of profitability; it generally ranks projects correctly and is consistent with the wealth maximization criterion. In practice, however, managers’ choice may be governed by other practical considerations also.

A formal financial evaluation of proposed capital expenditures has become a common practice among companies. A number of companies have a formal financial evaluation of almost three froths of their investment projects. Most companies subject more than 50% of the projects to some kind of formal evaluation. However, projects, such as replacement or worn-out equipment, welfare and statutorily required projects below certain limits, small value items like office equipment or furniture, replacement of assets of immediate requirements, etc., are not often formally evaluated.

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