CMA Exam Question - NPV, IRR, - Choosing Project


L

Lara Shub

I am completely stumped. Have been spinning my wheels trying to solve this
one:

I am evaluating which project to choose on a limited budget. There are four
projects in total. Choosing two - is no brainer - highest NPV and IRR.
Choosing one out of the two that are left is tough.

Project A - Investment - $200,000
NPV @ 12% - $23,773
IRR - 15%
Payback - 4.5 years
Economic Life - 8 years

Project B - Investment - $144,000
NPV @ 12% - $6,027
IRR - 14%
Payback - 2.9 years
Economic Life - 6 years

On the first glance, Project A has higher NPV and IRR, so it looks like it
should be chosen. However, when looking at the Payback and Economic Life -
Project B is much quicker at turning over. So instead of locking for 8
years, we may be free to invest in 6 years again.

How the heck would I choose among these two. I have tried everything -
assigning different weight to criterias, using weighted average of factors.

Could anyone suggest, how would you choose among projects?

Or, the risk is the same for both projects.
 
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B

Bob

Lara Shub said:
I am completely stumped. Have been spinning my wheels trying to solve this
one:

I am evaluating which project to choose on a limited budget. There are four
projects in total. Choosing two - is no brainer - highest NPV and IRR.
Choosing one out of the two that are left is tough.

Project A - Investment - $200,000
NPV @ 12% - $23,773
IRR - 15%
Payback - 4.5 years
Economic Life - 8 years

Project B - Investment - $144,000
NPV @ 12% - $6,027
IRR - 14%
Payback - 2.9 years
Economic Life - 6 years

On the first glance, Project A has higher NPV and IRR, so it looks like it
should be chosen. However, when looking at the Payback and Economic Life -
Project B is much quicker at turning over. So instead of locking for 8
years, we may be free to invest in 6 years again.

How the heck would I choose among these two. I have tried everything -
assigning different weight to criterias, using weighted average of factors.

Could anyone suggest, how would you choose among projects?

Or, the risk is the same for both projects.

did the problem specify what the "limited budget" is or for how long?
how can you say "Choosing two - is no brainer - highest NPV and IRR." --
as the NPV just discounts the returns and doesn't say anything about the
highest number is the best.
 
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L

Lara Shub

There are four projects in total, and we have $500K. The first two I was
referring to had:
NPV of $70K each,
Capital Investment of $106K and $130K respectively
IRR of 35% and 26%
Payback of 2.2 and 3.3 years.

That is why choosing these, as a number one choice and a number two choice
was relatively easy. The tough part is what to do with the remaining $264K,
as we have a choice of investing it in Project A or Project B.

However, comparing two is like comparing apples and oranges - one has a
better NPV and IRR and another - better Payback and quicker completion.

I have no idea how to solve this
 

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