Large grain farm in Montana - 35,000 acres

  

Private Power Generation, Transmission and Distribution of Natural Gas

  

Shares for sale in a Profitable Goldmine in Arizona

  

Real Estate

  

Integrated Facility Operations & Supply model in market tested (7yr) and ready for national launch.

  

Short term real estate investment with guaranteed return

  

Langley BC Cannabis - Summer 2019 Investment Proposal

  

Own part of renewable energy Anaerobic Digester in Canada with Excellent returns

  

Mining Expansion & Acquisition Opportunity

  

Short Term Real Estate Opportunity - Over 20 Years of Experience

  

Capital required to keep up with growth demands

  

EMPOWER WITH PRIME

  

LAST CHANCE !GREAT PASSIVE INCOME! Own part of a Natural Gas station in Ontario, Alberta or BC

  

Real Estate 2-3 yr 60%+ ROI...Multiple opportunities per week

  

Mobile Application for Planning Events

  

Village Specialized Education - Autism Focused Learning Tools

  

Investor/partner needed for business 'step-up'

  

Hubudub Ltd.

  

MyStory App

  

Roses Forever

  

Zollv a new way to watch videos online

  

Equity and dividend.

  

Dorscheid Brothers looking for investor partners, to become part of the team, in growing company.

  

Igor Acet Services

  

16% to 45% IRR - Turn Key Real Property, Pre-Construction & Organic Agriculture Opportunities

  

Structural Steel and Misc. Steel Fabrication and Erection

  

PURR-fect Harmony Licensing to Global Pet Product Company

  

Evotrux - "Airbnb for Freight"

  

Seeking Investor for Canadian Inventor - Baby/Kids Products & Retail Industry

  

Investor or partner

  

FIN Tech ecommerce app seeking strategic partners.

  

Kisik Construction Inc.

  

Biomass Energy Farm

  

EDO JAPAN FRANCHISE Start Up Business

  

Help our 30 yr SOUP BAR EXPAND! Help us Re-Brand!

  

Equity in Clean Tech Company

  

CBD Hemp Extraction, Investment Opportunity

  

Rapid Stor - Marketplace for Storage Spaces

  

Tomorrow's house Today

  

Genecos

  

 

Canadian Investment Network


Recent Blogs


Pitching Help Desk


Testimonials

"I have been an investor for 2 years. Through this site I have managed to finance 4 projects. I am very pleased with my membership. "
Dave M.

 BLOG >> July 2012

How to analyze an investment opportunity [Decision Making
Posted on July 10, 2012 @ 08:00:00 AM by Paul Meagher

Lately I've been researching formal methods that might be used to decide whether to invest in a project or not. Three commonly used metrics are:

  • Payback Period
  • Net Present Value (NPV)
  • Internal Rate of Return (IRR)

To compute these values, you need to specify a cashflow sequence where the first element in the cashflow sequence is a negative number denoting the investment amount. The next elements in the cashflow sequence are the net income amounts for year 1, year 2, up to year N. An example of a cashflow sequence would be:

year      0        1      2      3     
cashflow  -10,000  6,000  6,000  6,000 

A cashflow sequence like this would be sufficient to compute the payback period for an investment, which is simply the number of years it would take to earn back your initial investment. In this case, the payback period would be 1.67 years which is one useful investment metric to know when evaluating an investment opportunity.

The nice thing about payback period metric is that it is simple number to understand. One problem, however, with this metric is that it does not take into account the time value of money, or the idea that money in your pocket today is worth more than the same amount in your pocket a year from now (because money in your pocket today could be earning interest and be worth more a year from now). The Net Present Value calculation includes a discount rate factor that takes the time value of money into account.

The Net Present Value calculation involves computing the present values of a cashflow sequence given a discount rate. If you have a discount rate of, say, 5%, then the $6000 you estimate that you might earn a year from now, would be equivalent to a present value of $5714.4 (plus a year earning interest at 5%). You compute the present value of each projected cashflow, sum them up, and subtract it from your initial investment. If this "net present value" is greater than 0 than you should consider proceeding with the investment. If the net is less than 0, don't invest. NPV gives you simple rule for making a an investment decision, and the size of the NPV allows you to more accurately gauge how good the investment is because it takes into account the time value of money via a discount rate that you specify.

While technically the rate you enter into the NPV formula is a "discount rate", you can also construe the rate as the percent profit you would want to make in order for the project to be worth your while. As you increase the percent profit you would like to make, the NPV value returned will be smaller and smaller. You can keep increasing the profit percentage until you get an NPV of 0. The profit percentage that gets you an NPV of 0 is called the Internal Rate of Return (IRR) and is another useful number for deciding whether you should invest in a project or not. Obviously, the higher the IRR the better the investment. It is also a useful metric for comparing investment opportunities in an apples-to-apples manner.

Enough theory. How to do we actually compute these investment metrics?

Rather than trot out a bunch of formulas, I will instead trot out a bunch of PHP code that computes these investment metrics:

<?php

/**
* A set of functions for quick financial analysis of an investment
* opportunity and a series of projected cashflows.

* For further details and pros/cons of each function please refer
* to the respective wikipedia page:

*     payback_period 
*         http://en.wikipedia.org/wiki/Payback_period
*     
*     net present value 
*         http://en.wikipedia.org/wiki/Net_present_value
*         
*     internal rate of return
*         http://en.wikipedia.org/wiki/Internal_rate_of_return
*/

/**
* The total present value of a time series of cash flows.
*/
function npv($rate$cashflows) {
  
$total 0.0;
  foreach (
$cashflows AS $i=>$cashflow)
    
$total += $cashflow pow($rate$i);
  return 
sprintf("%01.2f"$total);
}

/**
* The IRR or Internal Rate of Return is the annualized effective 
* compounded return rate which can be earned on the invested 
* capital, i.e., the yield on the investment.
*/
function irr($cashflows$iterations=100) {
  
$rate 1.0;
  
$investment $cashflows[0];
  for (
$i=1$i <= ($iterations+1); $i++)
    
$rate *= (npv($rate$cashflows) / $investment);
  return 
sprintf("%01.2f"$rate 100);
}

/**
* The payback period refers to the length of time required
* for an investment to have its initial cost recovered.
*/
function payback($cashflows) {
  
$investment array_shift($cashflows);
  if (
$investment 0
    
$investment = -$investment;
  return 
sprintf("%01.2f"payback_of_investment($investment$cashflows));
}

function 
payback_of_investment($investment$cashflows) {
  
$total 0.0;
  
$years 0.0;
  
$cumulative = array();
  if ( (
count($cashflows)==0) OR (array_sum($cashflows) < $investment) ) 
    die(
"insufficient cashflows");
  foreach(
$cashflows AS $cashflow) {
    
$total += $cashflow;
    if (
$total $investment
      
$years += 1;
    
$cumulative[] = $total;
  }
  
$A $years;
  
$B $investment $cumulative[$years-1];
  
$C $cumulative[$years] - $cumulative[$years-1];
  return 
$A + ($B/$C);
}

?>

This code is a port of some python code found here.

To test drive these functions we can create a test script:

<?php

// Include our investment analysis functions
include "investment_analysis.php";

// Rate used to discount future cashflows to their present values (also 
// can think of this as the desired profit percentage).
$rate  0.05

// The cashflow value at index 0 is the investment amount (always a negative value)
// The cashflow value at index 1 to N can be positive (net inflows) or 
// negative (net outflows).
$cashflows = array(-10000600060006000);

// Now feed these parameters into the three investment functions we discussed
$payback payback($cashflows);
$npv     npv($rate$cashflows);
$irr     irr($cashflows);

// Output the results
echo "Payback is $payback years<br />";
echo 
"NPV is $ $npv<br />";
echo 
"IRR is $irr%<br />";

?>

The output of this script looks like this:

Payback is 1.67 years
NPV is $ 6339.49
IRR is 36.31%

Each of these numbers gives us a different perspective on a potential investment and together provides a useful set of formal metrics for analyzing the worthiness of an investment opportunity.

Permalink 

 Archive 
 

Categories


 Agriculture [70]
 Bayesian Inference [14]
 Books [15]
 Business Models [24]
 Causal Inference [2]
 Creativity [7]
 Decision Making [15]
 Decision Trees [8]
 Design [36]
 Eco-Green [4]
 Economics [11]
 Education [10]
 Energy [0]
 Entrepreneurship [59]
 Events [2]
 Farming [20]
 Finance [25]
 Future [15]
 Growth [18]
 Investing [24]
 Lean Startup [10]
 Leisure [5]
 Lens Model [9]
 Making [1]
 Management [9]
 Motivation [3]
 Nature [22]
 Patents & Trademarks [1]
 Permaculture [34]
 Psychology [1]
 Real Estate [2]
 Robots [1]
 Selling [11]
 Site News [14]
 Startups [12]
 Statistics [3]
 Systems Thinking [3]
 Trends [7]
 Useful Links [3]
 Valuation [1]
 Venture Capital [5]
 Video [2]
 Writing [2]