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project selection

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AM1969
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project selection

Postby AM1969 Mon Mar 23, 2015 3:10 pm

David is a Project Manager for Construction Company. He has been asked to help choose one of the four potential real estate projects. The management used internal rate of return technique for project selection. Which of the following projects should David recommend to the management?

Project A requires making an initial investment of $100,000 and will give monthly return of $5,000.

Project B requires making an initial investment of $200,000 and will give monthly return of $8,000.

Project C requires making an initial investment of $100,000 and will give annual return of $40,000.

Project D requires making an initial investment of $200,000 and will give annual return of $60,000.

ans is project A how? greater return from B . how is the IRR calculated here. Please tell.
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Re: project selection

Postby manishpn Mon Mar 23, 2015 9:19 pm

I hope you noticed that return for project A and B are monthly so you need to multiply it by 12 for annual returns and then calculate IRR.
Project with higher IRR is receomnded


Project investment Return IRR
A 100000 60000 0.6
B 200000 96000 0.48
C 100000 40000 0.4
D 200000 60000 0.3
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AM1969
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Re: project selection

Postby AM1969 Tue Mar 24, 2015 1:40 pm

I did notice monthly return and multiplied by 12. ..but not getting it right
can you tell me to calculate.
IRR cash out flow and inflow is 0
0= sum(FV/1+i^n)
0= -100000 + 60000/(1+i)^1

Is this the way I should claculate? not getting the right answer. Can you please correct me.
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Re: project selection

Postby AM1969 Wed Mar 25, 2015 1:21 pm

Saket can you help me with this calculation please?
Thanks
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Re: project selection

Postby AM1969 Thu Mar 26, 2015 9:22 pm

still waiting for the calculations ??
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Re: project selection

Postby jyotimayank Fri Mar 27, 2015 5:25 am

Let me explain the calculation part

Project A Investment 100000
Return rate 60000 per year so Payback period is 1 Year 8 months (or 100000/5000=20 months)
Project B Investment 200000
Return rate 96000 per year so Payback period is 2 Years 1 month (200000/8000= 25 months)
Project C Investment 100000
Return rate 40000 per year so Payback period is 2 Years 6 months
Project D Investment 200000
Return rate 60000 per year so Payback period is 3 Years 4 months

Looking at this data Project A have minimum payback period so Project A is selected
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manishpn
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Re: project selection

Postby manishpn Fri Mar 27, 2015 2:50 pm

Hi Jyoti this is IRR and not Payback period question :)
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Re: project selection

Postby manishpn Fri Mar 27, 2015 3:07 pm

Hi AM

i will take Project A as example

David is a Project Manager for Construction Company. He has been asked to help choose one of the four potential real estate projects. The management used internal rate of return technique for project selection. Which of the following projects should David recommend to the management?

Project A requires making an initial investment of $100,000 and will give monthly return of $5,000.
discounted rate IRR is calculated as IRR =((FV/PV) raise to (1-n) ) - 1 where
n= number of years for which IRR is calculated, FV = net cash flow (returns) over n years and PV = initial investment
In our question we have not provided years so you have to assume n=1

calculations is
IRR (%)
=((5000*12)/ 100000) - 1
=0.6-1
=-40%
Simlarly for Project B its -52%, C its -60% and D its -70%

so if you see highest IRR is Project A with -40% hence it should be selected

To avoind confusion, I had provided simple calculation in my previous response without considering discounted IRR
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Re: project selection

Postby saket Fri Mar 27, 2015 3:21 pm

The complete IRR calculation may not be needed in this question since you just want to get a feel of where the % returns are high. and which are quite clear from the options . manishpn has given example by taking one year time horizon

Let me know if this still require discussion and in exam less chance of getting question where you need to do this calculation.
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Re: project selection

Postby AM1969 Fri Mar 27, 2015 3:47 pm

David is a Project Manager for Construction Company. He has been asked to help choose one of the four potential real estate projects. The management used internal rate of return technique for project selection. Which of the following projects should David recommend to the management?

Project A requires making an initial investment of $100,000 and will give monthly return of $5,000.

Project B requires making an initial investment of $200,000 and will give monthly return of $8,000.

Project C requires making an initial investment of $100,000 and will give annual return of $40,000.

Project D requires making an initial investment of $200,000 and will give annual return of $60,000.

ans is project A how? greater return from B . how is the IRR calculated here. Please tell.


The formula given to us in Quampus maths flash card tells to calculate the IRR as follows
IRR cash out flow and inflow is 0
0= sum(FV/1+i^n)
but not getting the answer correct. what are the values to be put in the formula?


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Re: project selection

Postby saket Fri Mar 27, 2015 4:00 pm

Let me explain what Manish has already done , for one option

1. Since we are not aware of complete project duration we can assume this is only one year project
2. If its one year them we are investing 100,000 and getting 60,000 (5*12) mean rate is going to be negative
So as per formula
0 = - 100,0000 + 60,000 / (1+r/100)
Which can be written as
100,000 = 60,000 / (1+r/100)
100,000 = 60,000 (1-40/100)
100,000 = 60,000 / .6
100,000 = 100,000
So option one is giving - 40%

Simlarly for Project B its -52%, C its -60% and D its -70%

So -40 is good than any other one.
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Re: project selection

Postby AM1969 Fri Mar 27, 2015 8:35 pm

now I got it....what manish told in simple way was also good . I will use that quick way in exam. but I was keen to know about using the formula used in Quampus for my understanding.

Thanks Saket and Manish
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Re: project selection

Postby mariareese Tue Nov 07, 2017 6:21 am

I think IRR return is fair enough ..

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