PM Toolkit3

PM Toolkit3-1 Suppose you are studying two hardware lease proposals . Option 1 costs $4,000, but requires that the entire amount be paid in advance. Option2 cost $5,000, but the payments can be made $1,000 now and $1,000 per year for the next four years. If you do an NPV analysis assuming a 14 percent discount rate, which proposal is less expensive?What happens if you use an eight percent rate?

At 14% factor: Year 2

Lease Option 1 Factor PV of lease cost

Year 1 4000 1 4000

Lease Option 2 Factor PV of lease cost

1000 1 1000

1000 0.877 877

Year 3

Year 4

Year 5

Total

4000

1000 0.7695 769.5

1000 0.676 676

1000 0.592 592

3914.5

***Thus Option 2 is preferred if the discount rate is at 14% since it will cost below $4000.**** At 8% factor: Year 1

Lease Option 1 Factor PV of lease cost

4000 1 4000

Lease Option 2 Factor PV of lease cost

1000 1 1000

Year 2

Year 3

Year 4

Year 5

Total

4000

1000 0.926 926

1000 0.857 857

1000 0.794 794

1000 0.735 735

4312

**At 8% option 1 is preferred since it is lesser than option 2 which is 4312.**** NPV @ 14% is $3913.71 DCF0 = $1,000/(1+14%)^0 = $1,000 DCF1 = $1,000/(1+14%)^1 = 877.19 DCF2 = $1,000/(1+14%)^2 = 769.47 DCF3 = $1,000/(1+14%)^3 = 674.97 DCF4 = $1,000/(1+14%)^4 = 592.08 Net Present Value = $3913.71 Thus Option 2 is preferred if the discount rate is at 14% since it will cost below $4000 NPV @ 8% is $4312.13 DCF0 = $1,000/(1+8%)0 = $1,000 DCF1 = $1,000/(1+8%)1 = 925.93 DCF2 = $1,000/(1+8%)2 = 857.34 DCF3 = $1,000/(1+8%)3 = 793.83 DCF4 = $1,000/(1+8%)4 = 735.03 Net Present Value = $4312.13 Thus Option 1 is preferred if the discount rate is at 8% since it is lesser than than Option 2 which is 4312.

PM toolkit3-2 Assume the following facts: A project will cost $45,000 to develop. When the system becomes operational, after a one-year development period, operational costs will be $9,000 during each year of the system’s five year

useful life. The system will produce benefits of $30,000 in the first year of operation, and this figure will increase by a compound 10 % each year. What is the payback period for this project? ( Show graph) 1. Using the same facts, what is the ROI for this project? 2. Using the same facts, what is the NPV for this project?

Operational cost Benefits(10%)

1 9,000 30,000

2 9,000 33,000

3 9,000 36,300

4 9,000 39,930

5 9,000 43, 923

TOTAL 45,000 183153

Year

Cumulative System Costs

Cumulative System benefits

1 2 3 4 5

9,000 18,000 27,000 36,000 45,000

30,000 63,000 99300 139230 183153

Costs

Payback 200,000 180,000 160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 0

1

2

3 Year

Payback = cost of project/ annual cash inflows. = 45, 000/9,000 = 5 years 1. ROI = (total benefits – total costs) / total costs. = (183153-45,000)/ 45,000 ROI =3.07 % 2. NPV= Benefits-cost = 182853-45,000 = 137,853

4

5

6