Investing is the activity of providing some of the investor-owned resources to a legal entity, company or project in the hope that the investor will benefit. There are many things that you can use as an investment tool. ranging from financial securities such as stocks and bonds to various business projects
The problem is that not all instruments are suitable for investment. This means that investors must be observant and cautious when considering investment possibilities.
One aspect to consider in investment feasibility is the investment criteria. Why is that? Check out the following checks.
Understand investment rules
Investment criteria are various financial indicators. that comes as a benchmark for evaluating investments Investment Criteria are used to determine if an investment tool is feasible.
In this criterion, various financial aspects are taken into account. Since the amount of costs that an investor has to incur for a certain investment Possible profit amount, time period, inflation rate and interest rates
These investment criteria are important because as an investor, You definitely have to pay Want to make a profit and choose the best investment tool? whether in the form of securities or business projects
Investment Criteria and Formulas
1. Net Present Value (NPV)
Net present value (NPV) is the difference between the present value (PV) of an investor’s benefit or profit. with the present value of the costs the investor has to incur during the investment
Why is this NPV important? The logic is that as long as the investment persists, You have to pay extra. Whether it’s the consumption costs needed to run the project or just the additional investment in stocks. The value of the money you spend varies from year to year due to inflation.
For example, you invest in building a dormitory. The development target is 3 years with an initial capital of Rp 2 billion. It turns out that in the first year you have to pay again for consumption of 100 craftsmen of IDR 10,000,000 for 1 year, if in the second year you have to pay for consumption again. Of course the value is not 10,000,000 IDR for 100 artisans because food prices go up (inflation).
So how is NPV calculated? The NPV formula is:
- Z1 = Cash flow received for the 1st period
- Z2 = Cash flow received for the 2nd period
- r = discount rate The discount rate is a variable with a risk level and a time value of money. In this case, you can use the interest rate. potential risks or inflation
- X0 = Cash outflow in the range 0 (investments assuming you did not issue additional capital during the investment)
The investment is said to be possible if the NPV value > 0, and it is said to be impossible if the NPV < 0 to simplify the calculation. You can use NPV formulas in spreadsheet applications (Microsoft Excel, etc.).
2. Internal Rate of Return (IRR)
The internal rate of return (IRR) is a matrix used to estimate the potential profit from an investment. IRR can also be defined as a discount rate that can cause the NPV value to be 0, which indirectly means the higher the IRR value of the investment. higher project The project will be even better.
The IRR formula is:
IRR = i1 + (NPV1- (NPV1-NPV2) x i2-i1
i1 = original discount rate
i2 = discount rate with NPV near 0
NPV1 = Original NPV
NPV = NPV approaches 0
Here’s an explanation from Amelira Haris Nasution:
3. Total Benefit to Cost Ratio (Gross B/C Ratio)
The benefit-cost ratio is the ratio between the profits received and the costs that the investor incurs during the investment. In this case, the profits and costs are already under the discount rate. So the formula is:
cost-benefit ratio = (PV of investment profit) / (PV of investment cost)
An investment will be declared as impractical if the total B/C ratio is less than 1 and vice versa.
4. Profitability Ratio (PV/K)
Profitability Ratio is the ratio of the ratio of the amount of profit an investor can earn from an investment by the cost of capital issued. This indicator is intended to be measured as well. Profitability Ratio of the company or project
The project’s profitability ratio will approach the project’s B/C ratio. It can be said that a project is a practical investment tool if its PV/K value is >1, and it is said that it is not feasible otherwise.
The PV/K value is derived from the profit share between the capital gains minus operating costs with the initial investment. Note that these three factors are calculated using the discount rate.
The PV/K formula is:
PV/K = ((Bt-Ep)/1+i^t))/(Kt/1+i^t)
Bt = profit from investment in year t
Ep = Investment operating expenses
i = discount rate
Kt = capital issued for initial investment
Example of calculating investment criteria
Here are some examples of investment criteria.
It is well known that Investor A wants to invest in Project B with an investment of 10,000 capital per year projected at 1,000 and an annual profit of 5,000. How will the project be analyzed? Is this project possible to use as an investment tool?
|year||Total cost (a)||Profit (b)||Net Profit (c)= (ba)||Discount rate (d) with i= 10%||PV cost (a*d)||PV Profit (f)= (b*d)||NPV(g) =(c*d)|
NPV = 5163,147078.
Since it is greater than 0, in terms of NPV, this project has the potential to be used as an investment tool.
2. Total Benefit to Cost Ratio
With the benefit-to-cost ratio formula = PV of capital gains / PV of investment costs The results of the primary benefit analysis are:
cost-benefit ratio= 18953.93385/13790,78677 = 1.374391046
Since it is greater than 1, in terms of B/C ratio, this project is likely to be used as an investment tool.
using the same example problem. You just need to estimate the value of i which will cause NPV = 0 in this case the author uses 30%.
|Discount multiplier (h) with i= 30%||PV cost (a*h)||PV Profit (f)= (b*h)||NPV (g) =(d*h)|
IRR = i1 + (NPV1/ (NPV1-NPV2) x i2-i1
IRR = 10% + (5163.147078/(5163.147078- (-257.7209912)) x 30%-10%
IRR = 44.5%
This means that the business is worth doing.
4. Profitability Ratio (PV/K)
PV/K = ((Bt-Ep)/1+i^t))/(Kt/1+i^t)
|year||Total investment (a)||Operating costs (b)||Profit (c)||Discount factor (d) with i= 10%||Total investment (e)||PV operating costs (e)= (b*d)||PV Profit (c*d)|
PV/K = (18953.93385-3790.786769)/10,000 = 1.516314708
Since it is greater than 1, in terms of PV/K, this project is likely to be used as an investment tool.