PMP Certification: A Beginner s Guide

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Generally, if NPV is positive, the investment choice is a good one NPV in simple terms is the sum of PV for the period measured minus the investment costs for those same periods For example: To calculate NPV on a project (project A), use the sample data in Table 7-11 First, calculate the present value for income/revenue based on the interest rate as shown in the third column Then, calculate the present value of cost over the number of periods as shown in the fifth column Last, take the total present value of income/revenue minus the total costs and you get the net present value In this example, NPV = 481 290 = 191 Here s how this helps in the project selection process Take the example where the NPV of project A is 191 and compare this to another project (B) that has an NPV of 120 Which project has the most favorable NPV Even though they are both positive NPV, you would recommend project A to your sponsor; it has the higher value, if all other things are equal

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Future Value Future value is the value of an asset or cash at a specified date in the future that is equivalent in value to a specified sum today There are two ways to calculate FV:

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For an asset with simple annual interest: original investment * (1 + (interest rate * number of years)) For an asset with interest compounded annually: original investment * ((1 + interest rate) ^ number of years)

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Time Period

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0 1 2 3 Total

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Income/ Revenue

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0 100 200 300

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Present Value of Income/ Revenue at 10% Interest Rate Costs

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0 90 166 225 481 200 100 0 0

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Present Value of Cost at 10% Interest Rate

200 90 0 0 290

Table 7-11 Sample NPV Calculation

7: Project Cost Management

Consider the following examples from Investopediacom:

$1,000 invested for five years with simple annual interest of 10 percent would have a future value of $1,500 $1000 invested for five years at 10 percent, compounded annually, has a future value of $1,61051[7]

These calculations demonstrate that time literally is money the value of the money you have now is not the same as it will be in the future, and vice versa Therefore, it is important to know how to calculate the time value of money so that you can distinguish between the worth of investments that offer you returns at different times[8]

Internal Rate of Turn (IRR) The internal rate of return (IRR) is a capital budgeting metric used by firms to decide whether they should make investments It is also called discounted cash flow rate of return (DCFROR) or rate of return (ROR) IRR is an indicator of the efficiency or quality of an investment, as opposed to net present value (NPV), which indicates value or magnitude Here s an easy way to relate this to project management: Say, for example, you have to choose between projects A and B Project A has an IRR of 20 percent, and project B has an IRR of 10 percent Which do you choose

Answer: You would choose project A because it has a higher efficiency (internal rate of return on the dollars invested)

Payback Period Payback period is the number of time periods it takes to recover your investment in a project before you start making a profit For example, project A has a payback period of ten months, and project B has a payback period of 24 months Which would you choose to fund

Answer: You would choose project A because it has a shorter payback period (sometimes known as break-even point )

Opportunity Cost Opportunity cost analysis is an important part of a company s decision-making process but is not treated as an actual cost in any financial statement Here s an example of opportunity cost: If a person invests $10,000 in a particular stock, they are denying themselves the interest they could have earned by leaving the $10,000 in a bank account instead The opportunity cost of the decision to invest in stock is the value of the interest they would have made by leaving the money in the bank Note that opportunity cost is not the sum of the available alternatives when those alternatives are, in turn, mutually exclusive to each other The opportunity cost of the