Traditional Methods of Project Evaluation

Payback method and accounting rate of return have been used for a long time to the worth of capital projects. Although employed quite frequently, they both appear to be inadequate because they do not include the criterion of time value of money. To illustrate the techniques we will use the following numerical example.

A proposal requires an initial investment of Rs 100, has a life of five years, and annual after tax will be Rs 5, Rs 15, Rs 20, Rs 20, and Rs 10, in that order. To convert these numbers to cash flows, depreciation must be added back. Assuming five year straight line depreciation or Rs 20 each year, the annual cash flows will become Rs 25, Rs 35, Rs 40, Rs 40, and Rs 30. 

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