Measures of Project Worth

Measures of Project Worth

DOI: 10.4018/978-1-5225-3059-6.ch008

Abstract

Investments usually involve the procurement of assets for which using marginal analysis may not be adequate in evaluating their worth to an economic activity in an enterprise. Furthermore, all the costs involved in the purchase of fixed assets are not ordinarily charged to the account of a production period. It is against his background that this chapter focuses on the concept of measures of project worth with a view to enabling farmers to obviate related problems in capital budgeting, non-discounted measures of project worth (pay-back period, average rate of return), discounted measures of project worth, benefit-cost analysis, net present value, decision criteria in using the net present value, internal rate of return, calculating the IRR, and interpreting the IRR. Discussions were based on a review of related and relevant literature. Conclusions and recommendations are made based on the discussions.
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Introduction

Measures of project worth basically involve aggregating and comparing the costs and the benefits of a project to determine the values of the project as a whole. These measures of project worth are mainly divided into two broad categories namely discounted measures of project worth and undiscounted measures of project worth. Discounted measures of project work take into consideration the time value of money while undiscounted measures do not. Measures of project worth are typically employed to determine which among various projects is to be accepted or to be rejected for investment purposes.

Investments usually involve the procurement of assets for which adopting marginal analysis may not be suitable for evaluating its worth to an economic activity (Drummond & Godwin, (2004). It is impossible to buy or use a marginal unit of a mechanical device e.g. a tractor or a grinder as such an asset comes in all-or-nothing packages. Investment in fixed assets to all intents and purposes involves production periods in the long run. Costs involved in the purchase of fixed assets are not ordinarily charged to the account of a production period. That is the justification for the asset to decline in value, over the expected useful life span, due to wear and obsolescence. Furthermore, where the analysis involves choice between projects that will last several years and also have variously shaped costs and benefits streams, then simple direct comparison of the costs and benefits is less than accurate.

Because evaluating costs and returns on the margin is both impractical and inappropriate for all-or-nothing packages and because of time dimensions in the value of money, simple difference between total costs and total benefits is anything but satisfactory in the measurement of project worth. We must therefore determine and compare the present value of the expected costs and the present value of the expected benefits to determine the accurate measure of a project worth.

The determination of the present value today of some future value is, by definition, called discounting. So the determination of the worth of any project that employs the computation of the present value of some future value is referred to as using discounted measures of project worth. However, there are some measures of project worth that do not employ the discounting procedure. These are commonly referred to as non-discounted measures of project worth.

In the course of running a farm, investments have to be made. For the investments to be profitable, the investment decision must be based on valid analysis of the costs and returns. According to Dueling and Sherill (2006), decisions involving the commitment of present funds in exchange for future fund are referred to as investment decision. This chapter highlights the tools that are essentially used in reaching such investment decisions by the investing farmer with a view to improving profitability and enhancing enterprise expansion. The rest of the chapter is divided into Non-Discounted Measures of Project Worth and Discounted Measures of Project Worth. It is concluded with recommendations.

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