Financial Analysis Techniques: NPV and ROI
Financial Analysis Techniques like Net Present Value (NPV) and Return on Investment (ROI) are used to determine the value and return of a project. In the context of Agile EVM, these techniques can be used to estimate the value of the work done and the return achieved from a given increment of work. NPV calculates the present value of future cash flows, and ROI computes the ratio of investment gain to its cost. Both help to quantify the value delivered in financial terms.
Guide to Financial Analysis Techniques: NPV and ROI
Financial Analysis Techniques, particularly Net Present Value (NPV) and Return on Investment (ROI), are pivotal tools in Agile EVM (Earned Value Management).
1. Importance: These techniques allow for a numerical calculation of the financial value or benefit a project is expected to deliver over time, aiding to make informed strategic decisions, and manage resources effectively. By comparing NPV and ROI of different projects, we can prioritize projects that provide the best financial outputs.
2. What they are:
- NPV (Net Present Value) is a financial measure used to assess the profitability of an investment or project by converting future cash flows into today's dollars and calculating the net amount.
- ROI (Return on Investment) is a measure used to evaluate the efficiency of an investment. It compares the net profit of the investment to its cost.
3. How they work:
- NPV: It takes into account the time value of money. It subtracts the initial investment from the present value of the future cash flows. When the NPV is positive, it means that the present value of the future cash flows is greater than the initial investment, and the investment is profitable.
- ROI: It is calculated by dividing the net profit of the investment by the original cost then multiplying the result by 100%. The ROI with a higher percentage shows that the project's gains compare favorably to its cost.
Exam Tips: Answering Questions on Financial Analysis Techniques: NPV and ROI
- Understand the formula and correct instances to apply both NPV and ROI.
- For NPV, remember that a positive NPV means the investment should be considered, and a negative one means it should not based on financial criteria.
- For ROI, the higher the percentage, the better the investment.
- In the case of comparative questions, be sure to calculate both for all project options to determine which offers a better financial return.
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