5.

Investment Criteria

When a companies or investors investing their capitals, they must know is the capitals
that they invest can benefit them economically or not, so they don’t loss their assets when
investing to a company’s. To finds out that the investation is worthy or not, there are four criteria
that can be used to identify, such as payback period, net present value, internal rate of return, and
probability index. Those are the four criteria that can be use as a guideline for investors or
companies when they want to investing their capitals.

6. Payback Period

The payback period refers to the amount of time it takes to recover the cost of an
investment, payback period is very important to calculate the amount of times it needs to get the
payback on capital. The sooner payback period takes the better the business is.

The shorter the payback, the more desirable the investment. Conversely, the longer
payback the less desirable it is. But there’s some problem with the payback period calculation,
the payback period ignores the time value of money and interest rate or rate of return. Time value
of money (TVM) is the idea that money today is worth more than the same amount in the future
because of the present money’s earning potential. Most of others capital budgeting formula, such
as net present value, internal rate of return and others consider the TVM but the payback period
disregard the time value of money. It is determined by counting the number of years it takes to
recover the funds invested. Payback period doesn’t account for what happen after payback
occurs, it ignores an investment’s overall profitability.

7. Net Present Value (NPV)

Net present value is the difference between the present value of cash inflows and the
present value of cash outflows over a period of time. Net present value also has a close
relationship with the theory of “time value of money”, not like payback period who ignores
TVM net present value is considering the TVM. A positive net present value indicates that the
projected earnings generated by a projevt or investment. It’s assumed that an investmen with a
positive Net Present Value will be profitable. And an investment with negative net present value
will result in a net loss. This is the basic concept for the net present value rule, which dictates
that only investments with positive net present value should be considered.

8.Benefit Cost Ratio (BCR)

The benefit cost ratio or (benefit-to-cost ratio) is a comparison between all value of
benefits with all the cost of a project or investment. These benefit and costs are treated as a
monetary cash flows or their equivalents. It’s means depends on the value it’s indicating. For the
interpretation, refer to the following 3 generic ranges of BCR values.
 Value Range of Benefit Cost Ratio Generic Interpretation
BCR < 1 Investment option generates losses
BCR = 1 Investment option is neither profitable or loss
BCR > 1 Investment option is profitable

Benefit Cost Ratio also have the advantages and disadvantages, so there’s the pro and
cons of the Benefit Cost Ratio

PROS CONS
The BCR translate the absolute amounts of The BCR alone doesn’t indicate the liquidity or
benefits and costs into a ratio funding aspects of the analyzed options
It facilitates the comparison of the different It’s subject to various assumptions for the
investment or project alternatives discount rate, residual value and cash flow
forecast. These assumptions can significally
impact the outcome of a benefit cost analysisi
without considering the inheret insecurities of
these parameter
It considers the value of cash flows in
relation to the time of their occurence

9. Internal Rate of Return

Internal rate of return is a interest rate that make net present value (NPV) become 0 or
can be called profitability index. The higher the IRR, the higher the level of investment, and also
the higher the investment that invested. To compare the various options, the investment with the
highest IRR is considered the best. Internal rate of return have a criteria:

If IRR > MARR, then those business is worthy in economics way

Where:

MARR = Minimum Atractive Rate of Return

The ultimate goal of IRR is to identify the rate of discount, which makes the present
value of the sum of annual nominal cash inflows equal to the initial net cash outlay the
investment. Several method can be used when identify an expected return but IRR is often ideal
for analyzing the potential return of a new project that a company is considering undertaking.