problem in risk management knowledge area

Submitted by vijayavadrevu on Sat, 03/16/2013 - 12:02

A company has to make a choice between 2 projects, because available resources in money and kind are not sufficient to run both at the same time. Each project would take 9  months and would cost $250,000. The first project is a process optimization which would result in a cost reduction of $120,000 per year. The benefit would be acheived immediately after the end of the project

The second project would be the development of a new product which could produce the following net profits after the end of the project

1year $15000

2 year $125000

3 year $220000

Assumed is a discount rate of 5% per year Looking at the net present values of these projects' revenues in the first year 3 years, what is true?

A)both projects are equally attractive

B) available information is not sufficient

C)2nd project is more attractive

D) 1st project is more attractive

 

Answer is given as (D)

Can someone explain me as to how to solve this?

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sspawar

Sat, 03/16/2013 - 12:38

http://pmzilla.com/oliver-lehmann-question-2-about-present-value

http://pmzilla.com/question-6

 http://pmzilla.com/search/node/which%20would%20result%20in%20a%20cost%20....

vijayavadrevu

Sat, 03/16/2013 - 13:19

 Thank You Sir

rattanw

Mon, 03/18/2013 - 12:23

 Ok, here you go.

 

For the Ist project, Benefit is = $120,000 + $120,000 +$120,000 = $360,000

For the 2nd Project, Benefit is = $15,000 + ($125,000*0.95) + ($220,000*0.90) = $331,750

 

The project with higher benefit value realized over the time frame given, i.e. three years is more attractive, hence Project 1 is more attractive 

 

Tips to solve questions like these

a) Just remember, what the question is asking you.  In this case question asks which project is more attractive (barring option b), all other details are not relevant

b) do not get confused by statements like internal or external project, new product development or enhancements, cost of the project etc,.  For as a project manager, you're supposed to be equally committed to all kinds of projects you're leading.