project selection

Submitted by vijayavadrevu on Sat, 04/20/2013 - 12:02

Based on the information provided below, which project would you recommend for being pursued?

Project I, with BCR (Benefit Cost ratio) of 1:1.6;
Project II, with NPV of US $ 500,000;
Project III, with IRR (Internal rate of return) of 15%
Project IV, with opportunity cost of US $ 500,000.


Top of Form

A. Project I
B. Project III
C. Either Project II or IV
D. Can not say from the data provided

 

I have selected ( D ) where as the answer is given as option ( B )

Can someone explain as to how can a project be selected based on given input of 15% IRR alone?

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Hemant Tandon

Sun, 04/21/2013 - 02:00

Points to remember:-

  • Opportunity cost doesn't tell you anything about the merits of selecting any particular project, so, you can't decide on the basis of just opportunity cost.
  • BCR given in the question is not greater than 1, so, Project#1 is not a favourable option. Also, unless you know the criteria to select BCR, you cannot suggest whether a given value of BCR is favourable or not.
  • NPV and IRR are good options to select a Project.
 
Based on above points:-
  • Project#1 should not be pursued.
  • Project#2 should be pursued, however, it is not given as a separate option.
  • Project#3 should be pursued.
  • Project#4 doesn't provide any concrete information to decide.
 
So, answer#B seems to be correct.
 
Regards,
Hemant, PMP
 

vijayavadrevu

Sun, 04/21/2013 - 05:37

 Thank you very much for your explanation.

Can we say that,

IRR of 15% implies that for for Rs 100/ - invested, the return is Rs 115/-. Hence project 3 can be selected

NPV > 0 and hence Project 2 can be selected

Is my understanding right?

Regards

Vijaya

 

 

Hemant Tandon

Sun, 04/21/2013 - 18:00

I can partially answer your question. NPV part is simple to explain:-

  • NPV is greater than zero: You would be getting an even higher return than you desire.
  • When NPV is zero: You would be getting exactly the return you desire.
  • When NPV is less than zero (a negative number): You would be getting a lower return than you desire.
When several investments are considered, the alternative with the highest, positive NPV is the most profitable.
 
IRR part is little complex.  Points to remember: 
  • The Internal Rate of Return (IRR) is the discount rate at which the Net Present Value (NPV) of a project equals zero. 
  • If the IRR of a new project exceeds a company’s required rate of return, that project is desirable. 
  • If IRR falls below the required rate of return, the project should be rejected.

Apart from this, refer the below link which explains how to calculate the IRR of different projects.

 
Please note....Calculating IRR is not in scope of PMP exam, so, you can go through this link for self-knowledge.
 
Regards,
Hemant, PMP

 

cnpatilpmp2012 (not verified)

Sun, 04/21/2013 - 17:41

The option B (project 3 ) is correct because we need to percieve between NPV and IRR as other two options are not appropriate or doesn't make any sense. Between NPV and IRR , IRR is best option to select, unless you have option with all NPVs and bigger value to be selected..


 


Regards


CN Patil

sspawar

Sun, 04/21/2013 - 23:04

  

other trick

Q asking choose only  one project

 

option A is wrong

only B have one project

C have 2 project but have to reccomend only 1.

D have none project

hence B is correct

 

 refer http://pmzilla.com/irr-vs-npv

Regards