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Annex 3

Indicators Used in Assessment of General Economic Performance

Worked Example

Discount Rate = 0.05

Year
(n)
Costs
($)

Income
($)
Net Return
($)
Discount Factor*
Net Present Value
($)

Net Present Value
($)**
0
12,000
 
-12,000
1.0000
-12,000
- 12,000
1
2,300
5,900
3,600
0.9524
3,429
- 8,571
2
2,300
7,000
4,700
0.9070
4,263
- 4,308
3
2,300
9,000
6,700
0.8638
5,788
1,479
4
2,300
9,000
6,700
0.8227
5,512
6,991
5
2,300
9,000
6,700
0.7835
5,250
12,242
6
2,300
9,000
6,700
0.7462
5,000
17,241

* Discount Factor = 1 / (1 + Discount Rate)n
** Cumulative Values

Payback Time

The investment would be completely paid for about half way through the third year. The cost of the project ($12,000) is equal to all of the net return for years one and two, plus about half of the net return for year three. Note that no discounting is involved in calculation of the payback time.

Net Present Value

Clearly the Net Present Value is substantially greater than zero, so the Internal Rate of Return must, in turn, be substantially greater than the Discount Rate of 0.05%.

In fact, if the values in the above table are recalculated using a Discount Rate of 0.37% the Net Present Value is effectively zero at year 6. This is shown in the following table.

Discount Rate = 0.37

Year
(n)

Costs
($)
Income
($)
Net Return
($)
Discount Factor
Net Present Value
($)
Net Present Value
($)*
0
12,000
 
-12,000
1.0000
-12,000
- 12,000
1
2,300
5,900
3,600
0.7300
2,263
- 9,372
2
2,300
7,000
4,700
0.5328
2,504
- 6,868
3
2,300
9,000
6,700
0.3889
2,606
- 4,263
4
2,300
9,000
6,700
0.2839
1,902
- 2,361
5
2,300
9,000
6,700
0.2072
1,388
- 972
6
2,300
9,000
6,700
0.1512
1,013
41
* Cumulative Values

Thus the Internal Rate of Return is 37%.

Note that it is possible to expedite the process by using a spreadsheet, financial calculator or computer software capable of calculating values of the Internal Rate of Return.

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