How to determine the economic effect

Determining the economic effect shows how profitable it is for an enterprise to carry out one or another activity. Indicators are measured as a result of the difference in income from the activities of the enterprise and expenses spent on its implementation. Identifying the economic effect is important when implementing an investment project.

Instruction manual

one

Choose a convenient financial method for calculating 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 invested funds in project.

2

The NPV calculation formula is given below: NPV = NCF1 / (1 + Re) +

+ NCFi / (1 + Re) I, where

NCF (or FCF - free cash flow) - net cash flow on the i-th planning segment;

Re is the discount rate.

NPV and means the reduced income, i.e. income from the project given at the current time, and not for the future. If the NPV is greater than zero, then the funds will certainly appear as a result of the project. Thus, NPV shows the feasibility of carrying out an activity. If NPV is less than zero, forget about this project, it will not bring profit.

3

The internal rate (rate) of return (return on investment) (IRR) is an absolute value, unlike NPV. IRR is a measure of the discount rate at which the NPV is zero. Therefore, determine the internal rate of return at the rate of bank interest at which this project will not receive any profit or loss. To understand the dependence of NPV on IRR, plot a graph. The figure shows that at a low discount rate, the company makes a profit, with an increase in IRR, the company's profit decreases.

4

Identify the payback period of invested funds for the project (payback period). Analyze your project for an annual return on investment. The maximum payback period can be set by the enterprise itself, the main thing is to determine whether all the money spent on the project can return on time. Calculating one of the three indicators above, you cannot fully determine the economic effect of the project, and only when comparing all the indicators can you really get a final conclusion on the profit, profitability and payback period of the project.

note

Keep in mind that when calculating NPV risks are not taken into account at all, therefore, when comparing several projects using NPV, it is necessary to calculate risks and make adjustments in order to determine from all the projects of interest the one that suggests the most desired budget.

Useful advice

Using the absolute IRR, evaluate projects and compare them with each other. Thanks to the discount rate, the risks of the project are determined and profits are compared taking into account the risks.