What are the criteria of investment decisions?

Answer 1

There are several 'criteria' that could be used to assess whether a project is worth delving into. I will briefly outline three:

1. Net Present Value (NPV): Net present value is the computation of the present value of all the cash flows minus the required investment. This method takes into account the time value of money, that money loses value over time due to inflation. Thus it discounts all cash flows accordingly, sums this amount and subtracts the initial investment (that is the money paid for the project-initial investment and costs, discounted if necessary). After computing this, if the NPV is greater than zero, this project should be accepted because it adds value to the company, however if NPV is less than zero than the project should not be accepted because by accepting this, shareholders are losing value for their stock.
2. Payback: This is where the company would set a specific cut off payback period (the time for which the company would like to recover its initial investment, undiscounted) and accept a project if its meets that cut off period. For example if you have three investments with cash flows as followed:

a. -2000; 1000 1000 0b. -2000; 500 600 2000c. -2000; 0 2000 0According to the pay back rule of two years, the company would accept project A because it returns the initial invest of $2000 in the given period. The third option would be considered meeting this requirement as well, but because project A has cash flow earlier it triumphs. However if we use NPV assuming that discount rate is 15%, we would obtain the following:a. $-374.29b. $203.50c. $-487.71Thus it is important to note that there are many risks with this criterion. That is it doesn't discount cash flows and it ignores all cash flow beyond cut off period (as you can see with investment B, which has a high cash flow in the third year). But due to its simplicity, it is often used as ONE of several other calculations.

1. Discounted Payback: This criterion is similar to the previous, but it is the time until the discounted cash flows will recover investments in the project. Again like, the previous criterion, it has a set cut off period. However, this option eliminates one of the payback period's flaws as it takes into consideration the time value of money. Thus, this method discounts the cash flows each year to compute the present value of all cash flows to find at what length of time must the project last in order to offer a positive NPV (if you recall, NPV = Present Value of all Cash Flows - required investment). However, there is still the disadvantage that the cut off period ignores all future cash flows that may make the project more beneficial than the chosen one. (Click here for one of my previous answers as to how to calculate discounted payback period: How_do_you_calculate_discount_payback_period)

Answer 2

The criteria of investment decisions typically include factors such as expected return on investment, level of risk, liquidity, time horizon, and diversification. Other considerations may also include market conditions, projected cash flows, industry trends, and the investor's financial goals and risk tolerance. The specific criteria vary depending on the individual investor or institution making the decision.