Investment Appraisal: Decision-Rules
In this Chapter the discussion shifts to applications of the various investment decision-rules discussed in the previous Chapter. Some of the applications rely on the simple algebraic concepts already discussed in Chapter 2, while some are developed using the basic tool of the benefit-cost analyst – the spreadsheet. Some issues already raised in Chapter 2, such as the time value of money and the calculation of present value and internal rate of return, are explored further, while new concepts, such as comparison of projects under capital rationing, are introduced and discussed. Finally, the use of spreadsheets in project appraisal is discussed in detail.
We now turn to evaluating multi-period investment projects – projects that have a net benefit stream occurring over many years. The remainder of this Chapter aims at familiarizing the reader with the practical application of discounted cash flow (DCF) decision-making techniques. At the end of the section the reader should know how decisions are made: to accept or reject a particular project; to select a project from a number of alternatives; and, to rank a number of projects in order of priority. Slightly different DCF decision-rules apply in each case. Although some examples are given to illustrate the use of these techniques, the exercises at the end of this section are also useful.
The widespread availability and relatively low cost of personal computers have transformed the task of the project analyst. Electronic spreadsheets such as Excel, Lotus 1-2-3, and Quattro have greatly facilitated the previously laborious, computational side to benefit-cost analysis. Repetitive, mechanical calculations can now be performed at will, which has the enormous advantage of allowing more project options and alternative scenarios to be considered than ever before. However, it should not be assumed that the PC spreadsheet program can assist in the design or setting-up of the framework for the project analysis. This requires both skill and art on the part of the analyst. This section aims at familiarizing readers with the necessary techniques, framework, and computer skills.
As noted earlier, benefit-cost analysis (BCA) is a particular method of appraising and evaluating investment projects from a public interest perspective. In later parts of this book, in particular in Chapter 5, we will examine the main differences between private and social