Best Methods Of Valuation! Which five investment profitability assessment methods are your favorites?
There are five methods of best investment valuation, which are often used by financial analysts to date. An investment is said to be profitable if indeed the investment can make the financier richer thanks to that investment. In other words, the prosperity of the creator of the capital will be much greater after making his investment.
It is certainly in accordance with the purpose so that the value of the company can be maximized. The discussion related to 5 methods of assessing investment profitability are as follows:
Investment profitability assessment method
There are five ways of valuation of investment that the company itself has done in an aspect of investment. It aims to be able to measure whether the investment is profitable or vice versa. What are they?
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The first investment valuation method is Net Present Value
The author will then describe one of the examples from one of the sources, relating to the valuation of investments with NPV. For example, if you have purchased a piece of land for 50 million.
When it has been paid then there will be 1 company contacted. It went on to say that the company had willingly bought 60 million land next year. Does that say that the profit earned is 10 million?. Of course not, because it is worth it more than when the money itself needs to be considered. If 60 million will be acceptable over the next 1 year, then what is the present value that comes from that receipt?.
If the interest rate that has been considered is also relevant enough which is 15%, then the present value or abbreviated PV is 52.17 million rupiah. Therefore, there is a difference between pv receiving and pv self-expenditure or also referred to as net present value or abbreviated NPV is 2.17 million rupiah. Such a positive NPV also shows that PV receipts will be much greater compared to PV expenditures. Therefore, a positive NPV means that the expectation of investment will increase the wealth of the financier itself, so that the investment is considered so profitable.
So it can be said that the decision rule is as follows
You can accept all investment proposals that are expected to provide a positive NPV, and please when you give a negative NPV. In practice it will be much more difficult to get such results, but if viewed theoretically it can be possible. You should remember especially if in the npv condition 0, Whether the level of interest that we consider is relevant enough to determine it in the calculation of NPV that has considered the element of risk.
Who has considered the element of risk, if it is already then it will certainly be in accordance with the explanation that comes from the management of working capital so that the investment is also obligatory for you to accept. Thus, the calculation of npv requires two important activities, namely estimating cash flow and also determining the interest rate that is considered relevant.
Average Rate Of Return investment assessment method
Arguably, the average rate of return investment assessment method will use profit figures based on accounting when compared to the average value of the investment itself. there are several things to note and one of them is that the final investment value in each year will be reduced by depreciation. while the average value of the class is the Amount of the initial plus final investment divided in two. calculation rather than the average rate of return that will be traveled is by dividing the average profit after tax with the average investment.
Weaknesses that occur in the average rate of return method are
- How will the determination of the profit level or the so-called rate of return be considered feasible
- The concept contained in this method is accounting profit and not cash flow
- Ignoring the time value of money
- it is also said that the higher the average rate of return, the more attractive an investment will be
investment assessment method, payback period
Arguably this method is a way to be able to calculate how quickly the investment can be made again then the calculation will also produce in units of time that is year or month. weaknesses in the payback period are no attention to the value of time money
Neglected cash flow after the payback period
This is due to overcoming weaknesses because you have ignored the value of money. therefore what is tried here is the method of calculating payback period by doing present value of cash flow and also calculated based on the payback period.
Internal investment assessment method rate of return (IRR)
The understanding of this research method is the level that equates PV spending or cash out with PV receipts or cash in. This method of decision rule is the acceptance of investment that is expected to give the IRR greater equal to the level as seen as feasible.
Profitability index investment assessment method
Show that the profitability index itself is a comparison between pv cash in and PV cash out.
What is the best investment valuation method? This is best are the two methods namely the second and third namely the male and the payback period, which has the same drawback that is the neglect of the value of time money. when it is known that money has the value of money time.
The latter two methods, IRR and PI, have similarities to each other, which are to pay attention to the value of money and using the cash base. However, by looking at some of the weaknesses contained in the method.
There are at least three weaknesses related to the way investment scoring using the IRR method, namely weakness 1
interest rate calculated is the same number for each economic year. Note that i = 16.62% means that IRR1=IRR2 = IRR3 =IRR4 = 16.62%. with this IRR method, it is not possible to calculate the IRR which is likely to be different in each year.
Whereas if viewed theoretically alone then there will be different levels of interest in each year. for example I when it is estimated that IRR1=16%, IRR2=15%,IRR3=17%,IRR4=13%. then when you use a different R in each year it is most likely npv but that but IRR is not possible to calculate.
That’s some explanation of some ways of assessing the profitability of the investment and which can be your favorite in the future? Thanks.