izenbridge's pmp® math series: project selection : pv , npv, irr, bcr and payback period
DESCRIPTION
Video of this presentation can be found at : http://youtu.be/yIMMy8hh0WQ In this presentation we have introduced some of the techniques used while performing project selection, we have seen people getting questions related to PV, NPV , IRR , BCR and Payback period in their PMP exam. Project Selection falls under Project Integration Management Knowledge Area and it get executed before Project Charter get prepared.TRANSCRIPT
![Page 1: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/1.jpg)
© 2013 iZenBridge | CONFIDENTIAL
PMP is a registered trademark of the Project Management Institute, Inc.
PMP®
Math Series
Economic Model
![Page 2: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/2.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Present Value
Net Present Value
Internal Rate of Return
Benefit Cost Ratio
Payback Period
![Page 3: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/3.jpg)
© 2013 iZenBridge | CONFIDENTIAL
The time value of money.
The money you get in 5 years isn’t worth as money
you get today
![Page 4: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/4.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Present Value
![Page 5: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/5.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Present Value
• Value today of the future cash flow
• Present Value = FV / (1 + i)^ n
• i = Discount rate
• n = Period
• FV = Future Cash Inflow/ Outflow
Now
Year 1
Year 2
Year 3
![Page 6: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/6.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Present Value
• Discount Rate = 10%
• PV = 4000 / (1+10/100) ^2
• PV = 4000/ (1.1) ^2
• PV = 4000 / 1.21
• PV = 3305
• It mean 3305 USD earned today is equals to 4000 USD earned
after two year
Now
Year 1
Year 2 4000 USD
![Page 7: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/7.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Which Investment Option is Better ?
Option A :
Returns: 4000 USD after 2
years
Option B:
Returns: 3500 USD after 1
years
Discount Rate =
10% per annum
PV = 4000/(1.1) ^2
= 3305 USD PV = 3500/(1.1)
= 3181 USD
![Page 8: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/8.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Usages of Present Value (PV)
• Used as a base for calculating the Net Present Value (NPV)
• Simple investment decisions can be made using this technique
• Higher the PV the better the investment
![Page 9: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/9.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Net Present Value (NPV)
![Page 10: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/10.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Net Present Value (NPV)
• NPV is a measure of how much money a project can be
expected to return (in today’s present value).
• It’s a Sum of Inflow and outflow in present value term (mean
discounted based on duration)
Now
FV 1 (Year 1)
FV 2 (Year 2)
![Page 11: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/11.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Net Present Value
NPV = Sum (PV)
= Sum (FV / (1 + i)^ n)
i = Discount rate
n = Period
FV = Future Cash Inflow (+) / Outflow (-)
![Page 12: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/12.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Net Present Value
• Discount Rate = 10%
• NPV = -1000-1000 /((1+10/100) ^1)
• + 4000/((1+10/100)^2)
• = -1000 – 909 +3306
• = 1397 (This Project returns 1397 USD in present value
term)
Outflow 1000 USD (Now)
Outflow 1000 USD (Year 1)
Inflow 4000 USD (Year 2)
![Page 13: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/13.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Which Project to Select?
• Project A has a duration of 4 years and an NPV of $40,000,
• Project B has a duration of 3 years and an NPV of $45,000,
• Project C has a duration of 6 years and an NPV of $62,000
Which project will you select?
Go with Project C, Time value of money already considered in
NPV so years doesn’t matter
![Page 14: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/14.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Usages of Net Present Value (NPV)
• One of the frequently used tools for project selection
• Take in account inflow and outflow of cash
• Easy to calculate
• A negative value indicates that we are loosing money
• Higher the NPV the better the project
![Page 15: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/15.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Internal Rate of Return (IRR)
![Page 16: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/16.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Internal Rate of Return (IRR)
• IRR is a measure of how quickly the money invested in a
project will increase in value. It’s a rate of return which
calculate based on the inflow and outflow of the project.
![Page 17: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/17.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Internal Rate of Return (IRR)
• The rule is same like NPV, the difference is, now we need to
compute the rate (i) which equalizes the cash inflow and
outflow
0 = Sum (FV / (1 + i) ^ n)
i = IRR this is what we calculate
n = period
![Page 18: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/18.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Internal Rate Return (IRR)
• 0 = -1000-1000 /((1+i/100) ^1) + 4000/((1+i/100) ^2)
• If we put i = 56, it makes the equation balance, so in this case
IRR = 56%
Outflow 1000 USD (Now)
Outflow 1000 USD (Year 1)
Inflow 4000 USD (Year 2)
![Page 19: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/19.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Internal Rate of Return (IRR)
• Which Project you will select?
Project Name IRR Investment
Gold 6% 4,500,000
Silver 5.8% 1,700,000
Platinum 5.4 % 2,000,000
Copper 3% 1,000,000
![Page 20: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/20.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Usages of Internal Rate of Return (IRR)
• Frequently used in Project selection
• It does not require assumption of discount rate
• Gives the result in % term rather than absolute
• Higher the IRR the better the project
![Page 21: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/21.jpg)
© 2013 iZenBridge | CONFIDENTIAL
NPV represents the
project benefit in
absolute term like
100,000 USD
IRR represents the value
in proportion like 10%,
56%
We can get contradictory recommendations
from NPV and IRR, but in exam you do not
get such questions
NPV vs IRR
![Page 22: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/22.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Benefit Cost Ratio
![Page 23: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/23.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Benefit Cost Ratio
• Money project going to make versus its cost.
• Benefit/Cost OR Revenue/cost
• Remember : Revenue is not equals to Profit
![Page 24: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/24.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Benefit Cost Ratio (BCR)
• Greater Benefit<->Greater Ratio <-> Better project
![Page 25: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/25.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Benefit Cost Ratio (BCR)
• Which of the following projects do you select?
• A) Project Gold with a BCR of 0.9
• B) Project Silver with a CBR of 0.9 and cost of $100,000
• C) Project Diamond with a cost of $100,000 and benefits of
$110,000
• D) Project Platinum with a BCR of 1.2
a) 0.9 b) BCR = 1/0.9 = 1.11 c) 11/10 = 1.1 d) 1.2
• Answer: D
![Page 26: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/26.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Usages of Benefit Cost Ratio
• Ratio helps in visualizing the relative value
• May calculate considering Time Value of Money
• Simple to calculate and explain
• Ratio less than 1 indicate we are losing money
• Higher the value, the better it is.
![Page 27: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/27.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Payback Period
![Page 28: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/28.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Payback Period
• Time required to get originally invested amount back
• Smaller is better . Earlier we get money, better it is
![Page 29: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/29.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Payback Period
• Project A requires investment of $500,000. The project is
expected to generate $25K per quarter for the first year and
$100K per quarter after that. What is the payback period?
By when I get 500,000 Back?
First Year = 25K + 25K + 25K + 25K = 100K
(still need 400K)
Second Year = 100K + 100K+100K+ 100K =
400K (Done)
![Page 30: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/30.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Usages of Payback Period
• Helps in looking the investment in time dimension
• The sooner we get our money back is better
• Usually calculated without considering the time value of money
• One can calculate discounted payback period
![Page 31: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/31.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Exam Tip
Present Value
Higher is Better
Net Present Value
Higher is Better
Internal Rate of Return
Higher is Better
Benefit Cost Ratio
Higher is Better
Payback Period
Shorter is Better
![Page 32: iZenBridge's PMP® Math Series: Project Selection : PV , NPV, IRR, BCR and Payback Period](https://reader031.vdocuments.site/reader031/viewer/2022012313/54c569344a7959021c8b459f/html5/thumbnails/32.jpg)
© 2013 iZenBridge | CONFIDENTIAL
Stay Connected
Contact Us
www.iZenBridge.com
forum.izenbridge.com
Join Us @
Linkedin:
www.linkedin.com/company/izenbridge-consultancy-private-limited
Facebook:
https://www.facebook.com/izenbridge
Google+:
https://plus.google.com/+Izenbridge1