Hello Everyone,
I was taking a timed quiz on pmtraining.com and there was this question below. I knew it was a long computation question and it would eat up my 10 minutes to do 10 questions.
SO...remembering that rule of ROI is that quickest return is the project to choose, I computated $12M x 30% and then computated $3.9M x 4-$12M and the earnings for both was the same, $3.6M.
So I chose answer invest in the bank without doing all the monthly and quarterly computation. Plus I didn't know the formula!!!
Reason: From the bank investment I'm getting my ROI on a monthly time basis where I can invest the interest earned somewhere else and the ROI from the factory project's quarterly profit needs to to waited for two additional months. Time is money!!! The faster you get paid back the better your investment. So I chanced it and the answer was correct !!! Here's the question now for you to look at and how the site explained the answer.
Please confirm my logic with this scenario when profit quantity is the same but with different time for ROI. Always take the project with the quickest payback. :)
8. The banks in the Ukraine have raised the annual interest rates sharply to 30 percent. You have the option to invest your money either in Ukrainian banks or to build a small factory for a client. The total cost of building the factory will be $12 million but it will spread evenly over one year ($1 million payable by the end of each month for the next 12 months). The client will make a payment of $3.9 million at the end of each quarter from the start of the project. Which of the following is the best option (if you are only considering the return on investment)?
Invest the money in the bank for a year
In this scenario you are considering investing your money in the bank or building a factory. Since all transactions are not happening at the same point in time, we need to discount the cash flows and then determine the return on investment. Since the bank is offering a 30% annual interest rate (the opportunity cost if you decide to build the factory), you need to discount all the cash flows for the factory project by 2.5% (30% / 12) on a monthly basis. The discount formula is: Present Value (PV) = Future Value / (1 + interest rate)^period. Let’s use this formula to determine the net present value of all cash outflows: Month 1: PV = 1,000,000/(1+2.5%)^1 = 975,610 Month 2: PV = 1,000,000/(1+2.5%)^2 = 951,814 Month 3: PV = 1,000,000/(1+2.5%)^3 = 928,599 Month 4: PV = 1,000,000/(1+2.5%)^4 = 905,951 Month 5: PV = 1,000,000/(1+2.5%)^5 = 883,854 Month 6: PV = 1,000,000/(1+2.5%)^6 = 862,297 Month 7: PV = 1,000,000/(1+2.5%)^7 = 841,265 Month 8: PV = 1,000,000/(1+2.5%)^8 = 820,747 Month 9: PV = 1,000,000/(1+2.5%)^9 = 800,728 Month 10: PV = 1,000,000/(1+2.5%)^10 = 781,198 Month 11: PV = 1,000,000/(1+2.5%)^11 = 762,145 Month 12: PV = 1,000,000/(1+2.5%)^12 = 743,556 Adding these up we get the total PV of outflows = 10,257,765 Now let’s calculate the PV of all inflows using the same formula: Quarter 1: PV = 3,900,000/(1+2.5%)^3 = 3,621,538 Quarter 2: PV = 3,900,000/(1+2.5%)^6 = 3,362,958 Quarter 3: PV = 3,900,000/(1+2.5%)^9 = 3,122,841 Quarter 4: PV = 3,900,000/(1+2.5%)^12 = 2,899,868 Adding these up we get the total PV of inflows = 13,007,204 The return on investment (today) = (13,007,204 - 10,257,765)*100 / 10,257,765 = 27% Since the bank is offering an annual 30% return on investment, it is advisable not to undertake the project and leave the money in the bank account. [PMBOK® Guide 6th edition, Page 34, https://www.mathsisfun.com/money/net-present-value.html]
Knowledge Area / Topic Area: Project Integration Management
Process Group: Initiating
Your response: Invest the money in the bank for a year
Incorrect response: Build the factory for the client
Incorrect response: Both options offer the same payoff
Incorrect response: Information given is insufficient to determine the best option
Saving Changes...
|
|
|
