How do I evaluate business investment decisions?

Scope the Size and Affordability of the Business Investment.

The first step is to do a general scoping of the business investment project and make sure you have enough money in your pre-planned budget to cover the new investment. This is more of an approximation to ensure that the investment project does not take too much of your capital budget allocation. Doing so can save you a lot of time and money by eliminating any further analysis.

Evaluate Investment Payoff.

One of the best approaches in determining a business investment payoff time period is to use the payback period methodology. The payback period is the amount of time required for a business investment to repay its initial cost. The calculation is based on cash flows and not on profits. The concept of payback involves evaluating the worth of a business project based on how long it takes before its cost is fully recovered. When coming up with costs you need to take into account money, time equipment and people.

Project Anticipated Profits of the Investment

Once the original investment has been amortized, then forecast the profits that you see being generated from this project. This requires determining the net positive cash flow that will be coming back into the business. Net positive cash flow in regard to business investments involves cash received from the funds originally spent on the investment.

Evaluate Alternative Investments for Higher Returns

After figuring out the return on this particular business investment as well as the time period, then evaluate alternative investments for how this particular money can be deployed. The project with the highest rate of return is the preferred project. Also, projects with the shortest payback periods are preferred as longer payback periods increase the risk of unforeseen circumstances arising.

To do this you must keep in mind that that the estimated time period that the investment will be in use and then determine the profits that will be generated after the initial cost has been repaid. As far as unforeseen risk, you need to evaluate the risk of each investment and factor in some cushion in your return on investment calculation. Keep in mind the return on investment is the income that a business investment provides in a year.

Source:

The Management of Investment Decision; Donald Trone; 1995

More Information:

SolutionMatrix.com: Investment Decisions