Question on Cost

Submitted by farhanmazhari on Mon, 04/06/2015 - 14:33

Can anyone help me, how to calculate this.

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.
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.
 
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?
 
 
A_. Both projects are equally attractive.
B_. The first project is more attractive by app. 7%.
C_. The second project is more attractive by app. 5%.
D_. The first project is more attractive by app. 3%.

 

Forums: 
PMP / CAPM exam Question bank
  • Log in to post comments
  • 151 reads

coolpmp69

Mon, 04/06/2015 - 16:31

This thread may help you

http://pmzilla.com/question-need-explanation-please

coolpmp69

Mon, 04/06/2015 - 16:32

http://forums.oreilly.com/topic/2923-oliver-lehman-question/

farhanmazhari

Mon, 04/06/2015 - 19:32

Thanks bro

osunald

Mon, 04/06/2015 - 22:17

I did the calculations for these two projects using the EVA formula, but I'm not sure what's is the net profit for the first project;  and this scenario desn't provide the cost of capital either. The only true information given is the capital expenditure of $250,000, and the cost reduction of $120,00 a year, but again, not sure if the capital expenditure and cost of capital needs to be deduted from this amount. The second project does provide a net profit of $200,000 the 3rd. year., and it's saying that a discount rate of 5% is already assumed. 

If to the fist project we deduct the capital expenditure and cost of capital (assumed to 5% a year), this provides an EVA of $72,500 in 3 years. 

The second project the net profit is provided (and is unclear if the cost of capital needst to be deducted or has been deducted), "with an assumend 5% discount rate". So the EVA is either $220,000 or $182,500. (from $220,000-$37,500). eitherways none of the four answers options (A-D) seems to be logical or correct. 

If I have to go with an answer I'll go with letter "C", but for approx. 70% not 5%.

I would like to have other perspectives to this scenario.

osunald

Mon, 04/06/2015 - 22:22

My bad... is NPV the formula to utilize. I missed this on the bottom of the question. =(

Thanks.

jyotig

Fri, 04/10/2015 - 06:49

Sharing a link, this will definitely help you :)

https://www.youtube.com/watch?feature=player_embedded&v=yIMMy8hh0WQ