TOPIC: Question - Need to know how it is calculated

Can you please let me know which is the right answer and how the calulations are done?

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%.

Ans : D
PV=FV/(1+R)^N R=Rate of interest, N = number of years

Project 1
Yr1 $ 120,000/(1+0.05)^1 = $ 114,286
Yr2 $ 120,000/(1+0.05)^2 = $ 108,844
Yr2 $ 120,000/(1+0.05)^3 = $ 103,661
Total $ 326,791

Project 2
Yr1 $ 15,000/(1+0.05)^1 = $ 14,286
Yr2 $ 125,000/(1+0.05)^2 = $ 113,379
Yr2 $ 220,000/(1+0.05)^3 = $ 190,044
Total $ 317,709

compare PV of both projects = (326791-317709)/326791*100 = 3%

Rachel,

Please tell us where this question comes from. We want to make sure that the original question creator receives appropriate accreditation.

Thank you!

It came from oliver Lehman practice exam.

Sathish's approach looks correct to me -- I would go with D also.

Hi, can someone please explain two things:

1) Is a cost reduction and the net profits the same thing? ($120,000 and $15,000)?

Also, can you please explain the last step:

compare PV of both projects = (326791-317709)/326791*100 = 3%

What is the exact formula for this? I presume this is NPV? But, it doesn't match the NPV formula I found. If you could please provide greater clarification between your steps would be very helpful.

Also, is it safe to assume that the real PMP won't be this difficult? Is Oliver Lehmann's exams much more difficult than the real PMP? Thanks!

The formula used is the formula to calculate the percentage value
Percent Change = (New Value - Old Value) × 100%
Old Value|
Also hoping the real questions are not this tricky. Can't afford to spend 5 mins in one question..

Why don't you subtract cost for 1st year $250,000. 250,000/1.05= 238,095

Therefor NPV = 326,791-238,095 = 88,696

Thank you for the answer. Reviewing my answers to Oliver Lehmann's test now and could not figure this one out. His site and test has been pointed out as a great source: http:/www.oliverlehmann.com/pmp-self-test/75-free-questions.htm.

Great site here. Thank you.

2nd project is more attractive if 3rd year profit continue till 4th year. Why are we considering 3 years life span ?

Shyamal: The questions asks for only 3 years. See the final sentence of the question.

As a thumb rule, projects with higher cash inflows during the initial years will be more attractive....in case someone wants to save time in calculations.
Not sure if this holds good for all scenarios.