The economic effect determination shows how profitable it is for a company to carry out this or that activity. Indicators are measured as a result of the difference between the revenues from the business activities and the costs incurred in carrying them out. Making the economic effect visible is important when executing an investment project.
Choose a convenient financial method to calculate the economic effect: NPV (net present value) – net present value (another name – net present value), IRR (internal rate of return) – internal rate of return, payback period – payback period of funds invested in projects.
The formula to calculate the NPV is given below: NPV = NCF1 / (1 + Re) +… + NCFi / (1 + Re) I, where
NCF (or FCF – Free Cash Flow) – net cash flow in the ith planning segment;
Re is the discount rate.
NPV stands for diminished income, i.e. project income, given at a particular time and not in the future. If the NPV is more than zero, the funds will necessarily appear as a result of the project. In this way, the NCW demonstrates the feasibility of performing a particular activity. If the NPV is less than zero, forget about this project, it won’t make a profit.
The Internal Rate of Return (IRR) is an absolute value, unlike the NPV. The IRR is a measure of the discount rate where the NPV is zero. Therefore, determine the internal rate of return at the bank rate at which this project will receive neither profit nor loss. Create a chart to understand the relationship between NPV and IRR. The figure shows that with a low discount rate the company makes a profit, with an increase in the IRR the profit of the company decreases.
Determine the payback period of the invested resources for the project (payback period). Analyze your project to get an annual return on your investment. The maximum payback period can be determined by the company itself, the main thing is to determine whether all the money spent on the project can be recovered in time. By calculating any of these three indicators, you cannot fully determine the economic impact of the project, and only by comparing all the indicators, you can really draw a definitive conclusion about the project’s profit, profitability and payback period.