Q.2 Oliver Lehmann

Submitted by niteshrs on Tue, 07/12/2011 - 22:35

 2. A company has to make a choice between two projects, because the 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.
  1. The first project is a process optimization which would result in a cost reduction of $120,000 per year. This benefit would be achieved immediately after the end of the project.
     
  2. The second project would be the development of a new product which could produce the following net profits after the end of the project:

1. year:       $ 15,000
2. year: $ 125,000
3. year: $ 220,000

Assumed is a discount rate of 5% per year. Looking at the present values of the benefits of these projects in the first 3 years, what is true?
 
  Both projects are equally attractive.
  The first project is more attractive by app. 7%.
  The second project is more attractive by app. 5%.
  The first project is more attractive by app. 3%.

 

How do we arrive at D as the right choice? Thanks,

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rishiarien

Wed, 07/13/2011 - 05:41

Second project NPV


= 15000 / (1.05) + 125000/ sq (1.05)  + 220000/ Cu (1.05)


= 14285.714 + 113378.685 + 190044.272


= 317708.67


First Project NPV



= 120000/ 1.05 + 120000/ sq (1.05) + 120000/ Cu (1.05)


=114285.71 + 108843.54 + 103660.51


= 326789.76


To calculate percent


(326789.76 - 317708.67) x 100 / 326789.76


= approx 3% 


I hope such questions will not turn up in PMP else we would have to spend 5 minutes solving this question itself.

aaron

Wed, 07/13/2011 - 20:48

This question should not turn up on the exam. These are CFA Level 1 type of questions

rsang

Wed, 07/13/2011 - 06:14

 

I will try like this:

Calculate PV for 3 years @ 5% discount rate:- (PV = FV / (1 + rate)^n)

 Project 1)  cost reduction=profit (I assumed)

120000 + 114286 +  108844 = 343130

 Project 2) 

15000 + 119048 + 199546 = 333594

Now we can conclude that "first project is more attractive" 

now, 343130 - 333594 = 9536, which is approx 3 more.

 

And , even I doubt if such calculation questions will come for exam.