Question

I am a bit confused about this question and need the help (Project Management). Thanks

Use the case below to answer questions 1 & 2 (Adapted from PMBOK 6)

Company A was established 4 years ago. Its founders have recently become concerned about the competitiveness of the firm’s offerings and have asked the directors of product development and marketing to work together and prepare a list of potential projects.  

The product development and marketing directors identified three projects related to updating company A's existing products. And they believed all these three projects can be finished at the end of the first year. The first project would integrate Company A's current calendar app with its email app. The investment for the first year is $65,000. Revenues from the second year of the product’s launch were estimated to be $750,000. However, because the directors expected that a large percentage of the users would likely upgrade to this new product soon after its introduction, they projected that annual sales would decline by 10% annually in subsequent years. The directors speculated that company A was moderately likely to obtain a leadership position in email/calendar apps if this project were undertaken and felt this app made moderate use of the Web.  

The second project related to updating the expense report app. The directors estimated that this project would spend $20,800 in the first year. Sales estimated to be $250,000 in the second the year and to increase 5% annually in subsequent years. The directors speculated that completing this project would almost certainly maintain company A’s leadership position in the expense report category, although it made little use of the Web.

The last product enhancement project related to enhancing the existing portfolio tracking app. This project would require an investment of $39,000 for the first year and would generate $500,000 in the second-year sales. Sales were projected to increase 5% annually in subsequent years. The directors felt this project would have a high probability of maintaining company A’s leadership position in this category and the product would make moderate use of the Web.  

In evaluating these three projects, the founders believed it was reasonable to assume each product had a 3-year sales life. They also felt that a hurdle rate(discount rate) of 12 percent fairly reflected the company’s cost of capital. Based on this information answer these questions

Question 1. Provided that all the cash inflows are incurred at the end of year and each product has a 3-year sales, calculate the NPV for these three projects. (Hint: project life for each project is expected to be 4 years from project inception.)

Question 2. Assume the founders weigh a project’s NPV twice as much as both obtaining/retaining a leadership position and making use of the Web. Use the weighted factor scoring method to rank these projects. Criteria for scoring are listed as below.

• NPV > $2,000,000 – 3; $1,000,000 < NPV < $2,000,000 – 2; NPV <$1,000,000 – 1.

• Certainly or highly maintain leadership – 3; Moderately maintain leadership – 2; Low probability to obtain leadership – 1.

• Extensive use of Web – 3; Moderate use of Web – 2; Little or no use of Web – 1.

(Hint: the sum of the weights of all three criteria should be set as 1.00.)

Answer 1

Q.1) Net present value (NPV) is the difference between the present value of cash inflows and the present value of cash outflows over a period of time.

The following is the formula for calculating NPV:

In this equation:

C_t = net cash inflow during the period t

C_o = total initial investment costs

r = discount rate, and

t = number of time periods

project 1:

initial investment=65000$

Cash inflows for 1st-4th Year =0$, 750000$, 675000$, 607500$ (since sales are decreasing 10% per year)

Discount rate =12% (given)

Now according to formula above

NPV= 0+ 750000/1.12² +675000/1.12³ +607500/1.12⁴ -65000

        =$1,399,424.31

project 2:

initial investment=20800$

Cash inflows for 1st-4th Year =0$, 250000$, 262500$, 275625$ (since sales are increasing 5% per year)

NPV= 0+ 250000/1.12² +262500/1.12³ +275625/1.12⁴ -20800

   =$540,505.45

project 3:

initial investment=39000$

Cash inflows for 1st-4th Year =0$, 500000$, 525000$, 551250$ (since sales are increasing 5% per year)

NPV= 0+ 500000/1.12² +525000/1.12³ +551250/1.12⁴ -20800

    =$1,083,610.91

Q.2)

let weight of web use and leadership be x since they are equal. so weight of NPV is 2x.

Now sum of all weights must be 1

so x+x+2x=1 which gives x=.25

so weights are 0.5, 0.25, 0.25 for NPV leadership and web use respectively.

Project 1:

NPV score = 2 since $1,000,000 < NPV < $2,000,000

Leadership score=2 (Moderately maintained)

Web use score =2(Moderate use)

so project rank= weights*score = 0.5*2+0.25*2+0.25*2=2

Project 2:

NPV score = 1 since NPV < $1,000,000

Leadership score=3 (certainly maintained)

Web use score =1(little use)

so project rank= weights*score = 0.5*1+0.25*3+0.25*1=1.5

Project 3:

NPV score = 2 since $1,000,000 < NPV < $2,000,000

Leadership score=3 (highly maintained)

Web use score =2(moderate use)

so project rank= weights*score = 0.5*2+0.25*3+0.25*2=2.25