The role of investment for the macroeconomic system is difficult to overestimate. They affect many areas of society, regardless of the object of investment. However, the goal of any investor is to obtain an economic result, i.e., profit, therefore, indicators of return on investment are used to assess the possibility of obtaining income from investment activities. They reflect the possible amount of profit that the investor will receive, and the payback period of the invested assets.
Assessment of investment attractiveness
Before assessing the effectiveness of the project, investors study the attractiveness of the investment object. To do this, use the following methods:
- method of analysis of financial condition (assessed financial stability, liquidity of assets, the presence of receivables and payables, profitability of production);
- a method of economic analysis of activity (an assessment is made of the state of production assets, their load level and degree of wear, they study the business activity of the enterprise, the organization of business processes, the efficiency of use of human capital, staff qualifications);
- a method for assessing profitability and the risk of economic activity (conduct an analysis of investment risks).
The purpose of assessing the attractiveness of an investment project is to determine the relationship between profitability and risk.
Investment efficiency
Assessing the effectiveness of investments is the most important step in the decision-making process on whether to invest in a specific project. Since investment activity affects all spheres of life of the macroeconomic system, the effectiveness of investments should be considered from different angles. The larger the project, the more efficiency parameters should be considered: economic, commercial, technical, social, environmental and budget. Of course, economic efficiency is of paramount importance to the investor.
Economic assessment of return on investment
Economic evaluation of return on investment includes:
- analysis of the production capacity of the investment object;
- analysis of the level of technical depreciation of fixed assets and the need for modernization;
- analysis of the efficiency of production processes and automation;
- analysis of the application of scientific developments, know-how;
- analysis of the efficiency of labor use, including the number of workers and their qualifications, the social climate in the team, the availability of social benefits for workers.
Investment activity is associated with risks, and an economic analysis of the return on investment allows you to thoroughly examine the possible risks and predict the final result from investments.
To assess the profitability of investments, static and dynamic indicators are used.
Static Investment Performance Indicators
This group of indicators allows you to evaluate the profitability of the project as a whole and at any given time. These include:
- The payback period of investments, illustrating the period of time for which the invested assets will return to the investor in full.
- Return on Investment (ARR) ratio, which shows the ratio of financial investments to the total amount of funds invested in the project.
- Net financial investment is the amount of cash assets received as an investment less costs for taxes, raw materials and supplies.
Calculation of return on investment based on static indicators is quite simple, but it does not take into account many risks and does not make it possible to really evaluate the profitability of investments.
Dynamic indicators of investment performance
This group of indicators allows you to monitor the dynamics of project efficiency and makes it possible to predict the profitability of investments. Dynamic indicators include:
- Presented net project value (NPV), which reflects the net project income for the period.
- The Return on Investment Index (PI) shows the ratio of net present value to total investment.
- Internal rate of return (IRR), which allows you to determine the marginal level of profitability of the project.
In the calculation by the dynamic method, the bank deposit rate and the weighted average cost of capital are taken into account. If the interest on the bank deposit is higher than the expected profitability of the project, then investing in the project does not make sense, since investment risks are always higher than on the deposit.
Profitability concept
ROI reflects the level of return on investment. It allows you to evaluate how effectively the funds invested in the project were mastered. It is defined as the ratio of net profit received in the process of economic activity to the amount of funds invested in this project. Due to its versatility, the profitability indicator is widely used in assessing the efficiency of production in general, certain types of products and investment projects.
Calculation of return on investment
The return on investment (ROI) formula is as follows:
ROI = (Return on Investment - Investment Cost) / Investment Cost * 100.
This indicator helps to evaluate how effectively the funds invested in the project have been mastered.
To assess the profitability of the project for the full cycle of its life, the return on investment ratio (ARR) is also used. This indicator is often used to assess the feasibility of investing in a particular object and for a comparative analysis of investment projects.
ARR = Average annual net profit / 1⁄2 (Amount of investment-Salvage value of the project).
The relative return on investment is calculated through the index of return on investment (PI):
PI = NPV / Amount of investment.
This indicator reflects the level of income for each ruble invested. If the index is less than one, investment in the project is impractical.
A more accurate indicator is the discounted return on investment ratio. Discounting is used for long-term projects, investments in which have a run in time.
Project profitability assessment
It is important to evaluate the profitability of investments at all stages of the existence of an investment project: before investing, when comparing alternatives, in the process of project implementation and upon its completion.
If the rate of return on investment of the project is more than one, then the invested assets will pay off and bring profit to the investor. If the indicator is equal to one, a deeper analysis of the project's effectiveness should be carried out in order to make a decision on investment. If the return on investment is less than one, then the project, with a high degree of probability, will be unprofitable.
At first glance, evaluating the profitability of investments is simple, but in practice there are many factors that affect profitability, which are difficult to predict, therefore, when deciding on the investment of assets, a set of indicators is calculated: return on investment, net present value and internal rate of return of the project.
The profitability of investments is of paramount importance to the investor. To assess the return on investment, static and dynamic indicators are used. Static indicators are simple to calculate, but do not take into account the timing of investments and the influence of external factors. Dynamic illustrate the change in profitability over time. Investment return assessment is carried out at all stages of the project. Return on investment proves how efficiently the assets have been utilized and what financial result the investor can count on.