PM Toolkit3-1

Suppose you are studying two hardware lease proposals . Option 1 costs $4,000, but requires that the
entire amount be paid in advance. Option2 cost $5,000, but the payments can be made $1,000 now and
$1,000 per year for the next four years. If you do an NPV analysis assuming a 14 percent discount rate,
which proposal is less expensive?What happens if you use an eight percent rate?

At 14% factor:
Year 2

Lease Option 1
Factor
PV of lease cost

Year 1
4000
1
4000

Lease Option 2
Factor
PV of lease cost

1000
1
1000

1000
0.877
877

Year 3

Year 4

Year 5

Total

4000

1000
0.7695
769.5

1000
0.676
676

1000
0.592
592

3914.5

***Thus Option 2 is preferred if the discount rate is at 14% since it will cost below $4000.****
At 8% factor:
Year 1

Lease Option 1
Factor
PV of lease cost

4000
1
4000

Lease Option 2
Factor
PV of lease cost

1000
1
1000

Year 2

Year 3

Year 4

Year 5

Total

4000

1000
0.926
926

1000
0.857
857

1000
0.794
794

1000
0.735
735

4312

**At 8% option 1 is preferred since it is lesser than option 2 which is 4312.****

NPV @ 14% is $3913.71
DCF0 = $1,000/(1+14%)^0 = $1,000
DCF1 = $1,000/(1+14%)^1 = 877.19
DCF2 = $1,000/(1+14%)^2 = 769.47
DCF3 = $1,000/(1+14%)^3 = 674.97
DCF4 = $1,000/(1+14%)^4 = 592.08
Net Present Value = $3913.71
Thus Option 2 is preferred if the discount rate is at 14% since it will cost below $4000
NPV @ 8% is $4312.13
DCF0 = $1,000/(1+8%)0 = $1,000
DCF1 = $1,000/(1+8%)1 = 925.93
DCF2 = $1,000/(1+8%)2 = 857.34
DCF3 = $1,000/(1+8%)3 = 793.83
DCF4 = $1,000/(1+8%)4 = 735.03
Net Present Value = $4312.13
Thus Option 1 is preferred if the discount rate is at 8% since it is lesser than than Option 2 which
is 4312.

PM toolkit3-2
Assume the following facts:
A project will cost $45,000 to develop. When the system becomes operational, after a one-year
development period, operational costs will be $9,000 during each year of the systems five year

useful life. The system will produce benefits of $30,000 in the first year of operation, and this
figure will increase by a compound 10 % each year. What is the payback period for this project?
( Show graph)
1. Using the same facts, what is the ROI for this project?
2. Using the same facts, what is the NPV for this project?

Operational cost
Benefits(10%)

1
9,000
30,000

2
9,000
33,000

3
9,000
36,300

4
9,000
39,930

5
9,000
43, 923

TOTAL
45,000
183153

Year

Cumulative System Costs

Cumulative System benefits

1
2
3
4
5

9,000
18,000
27,000
36,000
45,000

30,000
63,000
99300
139230
183153

Costs

Payback
200,000
180,000
160,000
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
0

3
Year

Payback = cost of project/ annual cash inflows.

= 45, 000/9,000
= 5 years
1. ROI = (total benefits total costs) / total costs.
= (183153-45,000)/ 45,000
ROI =3.07 %
2. NPV= Benefits-cost
= 182853-45,000
= 137,853