COMPARISON OF THE NET PRESENT VALUE METHOD AND INTERNAL RATE OF RETURN METHOD OF EVALUATION METHODS OF INVESTMENT PROJECTS

Yıl 2019, Cilt: 7 Sayı: 2, 477 - 497, 30.08.2019

Begüm Öktem

https://doi.org/10.22139/jobs.586388

Öz

The main objectives of enterprises are seen as
increasing the value of the firm and maximizing shareholder value. Businesses
make financial and investment decisions while fulfilling these objectives. The
investment decision is a long-term strategic decision of the enterprise and the
capital budgeting decision is taken into consideration in the investment
decisions.

Project evaluation methods can be grouped as follows
considering the time value of money: (Çağlar, 1996)

1.Criteria which do not take into
account the time value of money (Static Assessment Methods)

1.1.Ratio of Profitability: It is necessary to divide the
annual profit of the project by the initial investment amount. (Türker, 1989)

1.2.Payback Period: In this method, the net money
inflow to be provided by the investment, is the length or number of years
required to pass in order to meet the investment amount.. (Akgüç, 2013)
Priority is given to projects with a short payback period. (Türker, 1989)

2.Criteria considering the time
value of money (Dynamic Assessment Methods)

2.1.Benefit Cost Ratio (Profitability
Index): It is
calculated by the ratio of the present value of the benefit obtained from a
project to the present value of the costs. (Campbell and Brown, 2003) If the
cash inflow is more than the amount invested, the profitability index is
greater than 1 and the project is accepted. (Crundwell, 2008)

2.2. Annual Equivalent
Expenditure Rate:
When choosing between alternative techniques to perform the same service or
work, annual peer expenses of these projects can be compared. The annual cost
of an investment project is equal to the total of operating expenses and the
share of the investment amount per one year.  In the examined method,
annual expenses are compared between alternative investment projects and the
project with the lowest annual cost is selected. (Akgüç, 2013)

2.3. Net Present Value Method: The net present value of a
project is calculated by subtracting the present value of capital expenditures
from the present value of cash inflows. (Dayanada, 2002) The positive net
present value for a given project indicates that the project benefits are
greater than the costs. (Campbell and Brown, 2003) Therefore, it is necessary
to discard projects with negative net present value and to undertake projects
with positive net present value (Ross, 1995).

2.4. Internal Rate of Return: The internal rate of return can
be defined as the discount rate and investment measure that equals the net
present value of all cash flows to zero. (Albornoz et al, 2018; Remer and
Nieto, 1995; Campbell and Brown, 2003; Türker, 1989) To accept an investment
project, the internal rate of return (discount rate) must be greater than the
minimum rate of return. (Hartman and Schafrick, 2004)

When selecting enterprises from projects, the use of
investment project evaluation methods should be as follows; (Gedik et al.,
2005)

 - In order of preference among various
projects; . Internal rate of return and cost-benefit ratio methods should be
prioritized.

- If the investment cost is equal, net present
value, cost-benefit ratio and internal rate of return methods should be used
for preference among projects.

 - If the investment projects will be preferred
according to their profitability, the internal rate of return method should be
preferred.

 - In the projects of product mix goods and
services, net present value and annual value method should be used if the
investment amount of the establishment period and the operating period expenses
are certain.

 - Acceptance or rejection of a single project;
If the cost of capital is known, net present value, internal rate of return,
cost-benefit ratio methods should be applied.

The advantages and disadvantages of net present
value method and internal rate of return method are as follows: The advantages
of the net present value method are; the project takes into account the entire
life span, taking into account time preferences by reducing future cash flows
to present value; and how much the value of the company and therefore the
presence of shareholders will increase. However, the disadvantages of the net
present value method are; the lack of clear and objective criteria for the
determination of this discount rate as a result of capital's consideration of
the opportunity cost (discount rate) as data in the calculations, affecting the
selection and ranking between investment projects by determining the discount
rate low or high, and not allowing much opportunity to compare different size
projects.

The advantages of the internal return ratio method
are; this method reflects the profitability of the invested capital,  show the maximum interest rate, easier
analysis and interpretation of internal profitability rates for business
people, taking into account the time factor and the economic life of the
investment, reducing the inflows and outflows required by the investment to the
same time level, making it a comparable objective method. On the other
hand, the disadvantages of the internal return rate method are: more than one
internal rate of return resulting from cash inflows may arise in the investment
project, making it difficult to determine which rate will be the basis for the
assessment; low-profit projects may cause non-preferred, does not directly
reflect the decision-maker's preferences over time; and calculation of the
method to be exhausting.  Considering
these advantages and disadvantages of enterprises in project appraisal is
important in terms of profitability, productivity and strategic position of the
enterprise.

The net present value method and the internal rate
of return method give the same results for accepting and rejecting decisions,
given a single project. (Campbell and Brown, 2003) However, this may not be the
case when a choice between two or more projects needs to be made and may give
different results. (Campbell and Brown, 2003) For this reason, it is explained
in the sample application which of the two projects should be selected among
the net present value method and the internal rate of return method.

 In order to make the application
understandable, the intersection point of the two curves shows the discount
terms that make the net present value of the projects equal. This rate is
approximately 15.31%. If the discount rate used in project valuation (accepted
minimum profit rate) is less than this value, project B will be preferred.
However, if the discount rate used is greater than this value, project A will
be preferred.

Anahtar Kelimeler

Evaluation of Investment Projects, Net Present Value, Internal Rate of Return

YATIRIM PROJELERİ DEĞERLENDİRME YÖNTEMLERİNDEN NET BUGÜNKÜ DEĞER YÖNTEMİ VE İÇ VERİM ORANI YÖNTEMİNİN KARŞILAŞTIRILMASI

Öz

Amaç: Bu çalışmanın amacı, yatırım projeleri değerlendirme
yöntemlerinden paranın zaman değerini dikkate alan (dinamik) yöntemler olan net
bugünkü değer yöntemi ve iç verim (karlılık) oranı yöntemi kullanılarak alternatif
iki yatırım projesinden birinin tercih edilmesi durumunun incelenmesidir. Böyle
bir seçimde net bugünkü değer ile iç karlılık oranı yöntemi farklı sonuçlar
verebilmektedir. Bu durum uygulama üzerinden gösterilmiştir.

Yöntem:  Bu
çalışmada öncelikle temel kavramlar olan; yatırım kavramı ve yatırım (sermaye)
bütçelemesi kavramları açıklanarak yatırım projeleri sınıflandırılmıştır.
Ardından yatırım kararı alınmasında gerekli verilere yer verilerek, yatırım
projesi değerlendirilmesinde kullanılan yöntemler paranın zaman değerini
dikkate alıp - almamasına göre teorik olarak tanımlanmıştır. Yatırım projesi
değerlendirme yöntemlerinden net bugünkü değer yöntemi ile iç verim (karlılık)
oranı yöntemi detaylı olarak açıklanmış, bu iki yöntem teorik olarak
karşılaştırılarak avantaj ve dezavantajlarına yer verilmiş ve ardından bir uygulama
üzerinden karşılaştırılmıştır.

Bulgular:
Bu çalışmada yatırım
projeleri değerlendirme yöntemleri kısaca açıklanarak, net bugünkü değer
yöntemi ve iç karlılık oranı yöntemi arasındaki ilişki hem teorik olarak, hem
de bir uygulama üzerinden gösterilmiştir. Uygulamayı anlaşılır kılmak için
oluşturulan şekilde iki eğrinin kesişim noktası projelerin net bugünkü
değerlerini birbirine eşit kılan verim oranlarını göstermektedir. Bu oran
yaklaşık % 15,31’dir.

Sonuç:
Proje değerlemesinde kullanılan
verim oranı (kabul edilen asgari karlılık oranı) %15,31 değerinden küçükse, B
projesi tercih edilecektir. Ancak, kullanılan verim oranı bu değerden büyükse A
projesi tercih edilecektir.

Anahtar Kelimeler

Yatırım Projelerinin Değerlendirilmesi, Net Bugünkü Değer, İç Verim Oranı

Kaynakça

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