Project Management Quiz: July 2010

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?

A. Both projects are equally attractive.
B. The first project is more attractive by approx. 7%.
C. The second project is more attractive by approx. 5%.
D. The first project is more attractive by approx. 3%.

The answer is D - The first project is more attractive by approx. 3%. The present value of all future cost savings of Project 1 is $326,789.76 which is calculated by using a discount rate of 5% and $120,000 savings per year for 3 years. The present value of net profit amounts of Project 2 is $317,708.67 which is calculated by using a discount rate of 5% and net profit savings of $15,000 in Year 1, $125,000 in Year 2 and $220,000 in Year 3. The difference between the 2 projects is $9,081.91 ($326,787.76 - $317,708.67). Project 1 is 3% greater than Project 2 ($9,081.91/$317,708.67). NOTE: The question asked you to look at the PRESENT Value of the benefits of the projects, not the NET PRESENT Value. Therefore, the cost of each project which is $250,000 is not taken account into the calculation.