Dear Community,
Can any of you advise, with solid justifications, the appropriate case scenarios to use specific metrics of financial evaluation?
I typically use 4 metrics (see below), and match them based on a justification system I use, but I would appreciate validation from you guys. :-)
My 4 metrics, and when I use them, are:
1) Net Present Value
I use this for very large investments whose projected financial benefit is expected to endure far into the future and for whose short-term benefit it is less relevant to consider.
Example: assessing whether the construction of a sub-strait tunnel in the Straits of Gibraltar to connect the European and African continents with a high-capacity motored traffic link is a worthwhile investment.
2) Break-even (time or money)
I use this for smaller investments where resources are scarcer, where the time factor is finite, and where other worthy projects are competing for the same funds and only 1 can be greenlit.
Example: deciding if a popular restaurant on the Bosphorous in Istanbul should choose between:
i) expanding the restaurant to go from a dining capacity of 80 to 115;
OR
ii) setting up a satelllite location in a secondary area with lower traffic but higher prices targeted at a more discerning customer base;
OR
iii) acquring a luxury boat to be able to offer concierge pick-up and drop-off from partner hotels and thereby expand patronage within certain customer segments.
3) Return on Investment (simple, non-time-weighted value of forecast gains divided by projected investment -1)
I also use this when the time-frame is finite, but when there is less sensitivity to the timing of the returns, and when there are a greater number of seemingly-similar options from which to choose.
Example: a lottery winner wishes to invest $5 Million of his surplus for a pre-defined, 5-year investment time-frame and is considering a choice of several investment vehicles.
4) Internal Rate of Return
I very rarely use this.
I mostly consider it a reverse NPV (or FV discount rate) where projected cash flows are known across options and other risk factors have been defined.
Example: deciding between 2 acquisitions across a range of factors, and using the IRR as an added filter to complete the selection. The ultimate selection is made either because the IRR is superior to other projects of similar risk profiles, OR the IRR exceeds the projected default option of staying the course.
So, I ask you:
i) What am I doing right?
ii) What am I doing wrong?
(edited)
