How can you measure the success of a long-term investment project?

1 Net present value

One of the most common and reliable methods to measure the success of a long-term investment project is to calculate its net present value (NPV). NPV is the difference between the present value of the future cash flows generated by the project and the present value of the initial investment. A positive NPV means that the project is profitable and exceeds the required rate of return, while a negative NPV means that the project is unprofitable and should be rejected. NPV can also be used to rank multiple projects based on their profitability.

2 Internal rate of return

Another method to measure the success of a long-term investment project is to calculate its internal rate of return (IRR). IRR is the discount rate that makes the NPV of the project equal to zero. In other words, it is the annualized rate of return that the project can generate over its lifetime. A higher IRR means that the project is more profitable and efficient, while a lower IRR means that the project is less profitable and efficient. IRR can also be compared to the required rate of return or the cost of capital to determine if the project is acceptable or not.

3 Payback period

A third method to measure the success of a long-term investment project is to calculate its payback period. Payback period is the number of years it takes for the project to recover its initial investment from the cash flows it produces. A shorter payback period means that the project is less risky and more liquid, while a longer payback period means that the project is more risky and less liquid. Payback period can also be used as a screening tool to eliminate projects that take too long to pay back or have an uncertain cash flow pattern.

4 Profitability index

A fourth method to measure the success of a long-term investment project is to calculate its profitability index (PI). PI is the ratio of the present value of the future cash flows generated by the project to the present value of the initial investment. A PI greater than one means that the project is profitable and creates value, while a PI less than one means that the project is unprofitable and destroys value. PI can also be used to rank multiple projects based on their value creation potential.

5 Sensitivity analysis

A fifth method to measure the success of a long-term investment project is to perform a sensitivity analysis. Sensitivity analysis is a technique that examines how the NPV, IRR, payback period, or PI of the project change when one or more of the key assumptions or variables are altered. For example, you can test how the project's performance is affected by changes in the sales volume, price, cost, discount rate, or inflation rate. Sensitivity analysis can help you identify the most critical factors that influence the project's success and assess the risk and uncertainty involved in the project.

6 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?