Finance Criteria and Techniques Used to Evaluate a Capital Project

Question:-

Discuss criteria and techniques used to evaluate a capital project. Which criteria and techniques do you consider the most useful?

Answer:-

It is essential to evaluate a capital project in order to analyze the potential and viability of the project. Capital projects are very risky projects and if the organization cannot evaluate the project effectively, it may suffer a huge loss. There are various techniques that could be employed to evaluate a capital project such as payback period, net value method, internal rate of return, and many more.

Payback period: It is one of the popular methods of evaluating a capital project and it is also easy to calculate. It is a calculation of how long it will take to get the original investment back. It is one of the key methods to evaluate a capital project but it has one limitation that it does not consider the time value of money (Yang, 2018).

Net present value: It uses the required rate of return of the investor in order to calculate the present value of future cash flow from the project. It considers the time value of money and hence it more suitable to evaluate a capital project compared to the payback period.

Internal rate of return: It is a simpler variation of the net present value method. It uses a discount rate that makes the present value of the future cash flows equal to zero.

After analyzing the above techniques, it can be said that net present value is the most useful technique to evaluate a capital project and hence as a finance manager I would use the same technique because it will provide an accurate figure of the capital project (Zore et al., 2018).