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COSTING AND PROJECT EVALUATION
Most proprietary spreadsheets have procedures for calculating the cumulative NPW
from a listing of the yearly net annual revenue (profit). Spreadsheets are useful tools for
economic analysis and project evaluation.
6.10.4. Rate of return calculations
Cash-flow figures do not show how well the capital invested is being used; two projects
with widely different capital costs may give similar cumulative cash-flow figures. Some
way of measuring the performance of the capital invested is needed. Rate of return (ROR),
which is the ratio of annual profit to investment, is a simple index of the performance
of the money invested. Though basically a simple concept, the calculation of the ROR is
complicated by the fact that the annual profit (net cash flow) will not be constant over
the life of the project. The simplest method is to base the ROR on the average income
over the life of the project and the original investment.

Cumulative net cash flow at end of project
ROR D ð 100 per cent 6.11
Life of project ð original investment
From Figure 6.8.

Cumulative income D F C
Investment D C
Life of project D G
F C
then, ROR D ð 100 per cent
C ð G
The rate of return is often calculated for the anticipated best year of the project: the
year in which the net cash flow is greatest. It can also be based on the book value
of the investment, the investment after allowing for depreciation. Simple rate of return
calculations take no account of the time value of money.

6.10.5. Discounted cash-flow rate of return (DCFRR)
Discounted cash-flow analysis, used to calculate the present worth of future earnings
(Section 6.10.3), is sensitive to the interest rate assumed. By calculating the NPW for
various interest rates, it is possible to find an interest rate at which the cumulative net
present worth at the end of the project is zero. This particular rate is called the “discounted
cash-flow rate of return” (DCFRR) and is a measure of the maximum rate that the project
could pay and still break even by the end of the project life.

nDt
NFW

D 0 6.12
0 n
1 C r
nD1
0
where r D the discounted cash-flow rate of return (per cent/100),
NFW D the future worth of the net cash flow in year n,
t D the life of the project, years.