The competitiveness and sustainability of an organization's activities are largely determined by the efficiency of using its capital investments. They represent a set of economic resources allocated for the reproduction of fixed assets. In other words, these are investments in fixed assets or the costs of acquiring, expanding, renovating machinery, equipment, buildings, etc.
Instructions
Step 1
Remember that there are several ways to determine the return on investment. One of the most widely used methods is the method of determining the effectiveness of investments in terms of payback period. It consists in determining the number of years required to fully recover the costs, i.e. the moment when investments begin to make a profit. When choosing an investment project, preference should be given to the one with the shortest payback period. Calculating the payback period is pretty straightforward. It is determined by dividing the amount of capital investments by the amount of annual income they bring.
Step 2
You can use the simple rate of return method to determine the effectiveness of your capital investment. It consists in comparing the average return on investment and the cost of the project. This method is quite simple and convenient in calculations, but it does not allow judging the effectiveness of projects that have an equal simple rate of return, but different amounts of investments.
Step 3
If you want to analyze the dynamic performance of your investment, then use the Net Present Value (NPV) metric. This indicator belongs to the group of cash flow discounting methods, i.e. bringing their future value to the present time. Net present value is calculated as the difference between the value of the present value of the cash flow and the amount of the initial investment. If this indicator takes a positive value, then the project will reimburse the initial investment and provide the necessary profit, as well as its some reserve. Otherwise, the required profit is not provided, the project is considered unprofitable.
Step 4
On the basis of the net present value, the internal rate of return is calculated, which is the value of the discount indicator at which the current value of investments is equal to the cash flow provided at their expense. If this indicator exceeds the amount of invested capital, then the project is accepted, if it is lower than the amount of investment, then the project is rejected.
