How can you identify the most financially attractive investment? Make the right choice and your business will bloom with new revenue and added value. Make the wrong choice and you will spend years untangling from an unwise investment and incurring substantial financial losses.
The easiest and most common method to evaluate a business investment is by calculating a static pro forma return on investment (ROI). The pro forma return calculation looks at what will be when the investment is fully operational or stabilized.
The Internal Rate of Return (IRR) calculation takes into account the time value of money. The IRR calculation takes a series of investment inflows and capital outflows and returns the average annual rate of return over the investment period to yield a zero net present value (NPV).
And a third method is net present value.
Net Present Value (NPV) is the cousin of IRR. The differences are with IRR you solve for the average annual return to get a zero NPV while the NPV calculation shows the value in today’s dollars from a series of future investment flows. You need to determine the annual discount rate to solve for the net present value for your investment opportunity. This involves substantial guesswork and is prone to error so be careful when selecting the discount rate to apply to future cash flows.
Choose carefully from among your investment options during your financial planning process. You have a finite amount of disposable cash for growth opportunities. Your strategic investment plan should include a calculation of return on investment (ROI), net present value (NPV), and internal rate of return (IRR) for each business opportunity.
- The Problems with IRR (devrealestateconsultant.wordpress.com)
- NPV a Real Estate Perspective (devrealestateconsultant.wordpress.com)
- To Build or Not to Build: A Financial Analysis of Building a Ship (gcaptain.com)
- IRR Internal Rate of Return (devrealestateconsultant.wordpress.com)
- FMRR Modified IRR for Real Estate (devrealestateconsultant.wordpress.com)