Static investment appraisal methods

Static investment appraisal methods play a significant role in the rough evaluation of investment opportunities in practice due to their simpler applicability and comprehensibility. In static investment appraisal methods, the income and expenses attributable to the asset are itemised and averaged. These averages are decisive for the relevant decision, whereby the factor of time is disregarded – this is simultaneously the greatest weakness of static investment appraisal methods, as the differing timing of payments is not adequately taken into account. For example, although expenses are itemised in the form of depreciation, the outlay made at the beginning of the investment remains unconsidered in the calculation or is merely taken into account in the form of imputed interest (as an expense).

Significant forms of static investment appraisal methods are the cost comparison method, the profit comparison method, the static profitability calculation, and the static payback period calculation – all of which are presented in an overview below.

Cost comparison calculation

Cost-comparison calculation determines the profitability of several projects based on the attributable costs or cost savings in the case of a rationalisation investment. The cost-comparison calculation focuses on selecting the investment with the lowest average costs, taking into account average period costs to compensate for fluctuations. Typically, the following cost types (which can be divided into fixed and variable costs) should be included in the cost-comparison calculation: wages, salaries and ancillary wage costs, material costs, personnel costs, insurance costs, energy costs, maintenance and repair costs, calculated depreciation, and calculated interest. Cost-comparison calculation is often used when assessing replacement investments.

Profit comparison calculation

The profit comparison method is a further development of the cost comparison method. The profit comparison method focuses on selecting the investment with the highest average profit (as an absolute value) and avoiding projects with losses. Derived from the profit comparison method, the critical quantity or break-even quantity can also be calculated. The critical quantity denotes, for example, the quantity or number of units at which alternative investments are equivalent.

Static profitability calculation

The profitability index aims to select the investment with the highest average return, excluding projects with a return below the minimum required rate of return. The marginal cost of capital is generally used as the cost of financing (in terms of the minimum required rate of return). Profitability calculations can be used to compare projects with different investment costs – profitability calculations ideally supplement profit comparison calculations.

Static Amortisation Calculation

The static payback period - in contrast to the static profitability calculation - considers the time required to recoup the investment costs from net income surpluses (pay-off period). The shorter the payback period, the more advantageous the investment. The payback period is often used to assess the risk of investment projects. The payback period can provide clarity as to the extent to which there is coverage with industry-specific empirical values.

Compared to other investment appraisal methods, the payback period calculation does not use accounting figures but is based on cash flows. This cash flow is fundamentally derived from profit and adjusts it for non-cash expenses (such as depreciation) and income. Specifically, the "cash flow from operating activities" is used for the calculation, as changes in working capital are not taken into account.

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