Oliver lehmann question

Submitted by danielkoshy on Fri, 02/21/2014 - 20:55

Hello

           Could someone please help me regarding this question?

 

  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%.

The answer is d.

 

 

 

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narinder

Sat, 02/22/2014 - 12:51

As the future values are already given, we have to calculate the present value for all the figures given in the question:

As the formula for PV is FV/(1+r)^n where r=discounted rate and n= no. of year

For Project 1:

First year the FV is $ 120,000 so the PV will be: 120000/(1+.05)^1= $ 114,285

similarly for second year the PV will be: 120000/(1+.05)^2= $ 108,843

and for third year PV: 120000/(1+.05)^3= $ 103,668

Net PV for Project 1: $ 326,796 and the net profit will be : $ 76,796 which is 30.71% profit with the spending of $250,000

For Project 2, the PV values will be as below:

1st year PV: $ 14285

2nd Year PV: $ 113378

3rd Year PV: 190048

Net PV for Project 2: $ 317,711 and the net profit will be : $ 67,711 which is 27.08% profit with the spending of $250,000

So the 1st project is approx. 3% more attractive than 2nd Project

Regards

Narinder 

 

danielkoshy

Sat, 02/22/2014 - 18:02

thanks narinder,really appreciate it.

( but seriously I cant imagine doing all this calculation during the exam.) . Good to know it though.

abhinavpraneet

Tue, 02/25/2014 - 21:47

Daniel,

My advice would be to mark such a question for Review later when you have gone through all 200 questions once. That way 2 things happen:

1. Firstly you do not waste precious time in the first pass pondering over the calculations and equations.

2. In your review, you are mentally satisfied about going through all questions, and can be more relaxed in attempting lengthy calculations.

Finally, do NOT leave any calculation/equation based question. Those are basically "gimme", that do not require a great deal of interpretation or thinking, but only some calculations.