PMP®

Math Series
Economic Model

PMP is a registered trademark of the Project Management Institute, Inc.

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 Present Value

Net Present Value

Internal Rate of Return

Benefit Cost Ratio

Payback Period

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 The time value of money.

The money you get in 5 years isn’t worth as money

you get today

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 Present Value

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 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 2

Year 1 Year 3

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 Present Value
Year 2 4000
Now USD

Year 1

• 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

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 Which Investment Option is Better ?

Option A : Option B:
Returns: 4000 USD after 2 Returns: 3500 USD after 1
years years

Discount Rate =
10% per annum

PV = 4000/(1.1) ^2 PV = 3500/(1.1)
= 3305 USD = 3181 USD

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 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

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Net Present Value (NPV)

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 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 2 (Year 2)

FV 1 (Year 1)

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 Net Present Value

NPV = Sum (PV)

= Sum (FV / (1 + i)^ n)

i = Discount rate
n = Period
FV = Future Cash Inflow (+) / Outflow (-)

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 Net Present Value
Outflow 1000 Inflow 4000 USD
USD (Now) (Year 2)

Outflow 1000
USD (Year 1)

• 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)

© 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

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 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

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Internal Rate of Return (IRR)

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 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.

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 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

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 Internal Rate Return (IRR)
Outflow 1000 Inflow 4000 USD
USD (Now) (Year 2)

Outflow 1000
USD (Year 1)

• 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%

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 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

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 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

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 NPV vs IRR

NPV represents the IRR represents the value

project benefit in in proportion like 10%,
absolute term like 56%
100,000 USD

We can get contradictory recommendations

from NPV and IRR, but in exam you do not
get such questions

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Benefit Cost Ratio

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 Benefit Cost Ratio

• Money project going to make versus its cost.

• Benefit/Cost OR Revenue/cost
• Remember : Revenue is not equals to Profit

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 Benefit Cost Ratio (BCR)

• Greater Benefit<->Greater Ratio <-> Better project

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 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

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 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.

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 Payback Period

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 Payback Period

• Time required to get originally invested amount back

• Smaller is better . Earlier we get money, better it is

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 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)

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 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

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 Present Higher is
Value Better

Net Present Higher is

Value Better

Internal Rate Higher is

Exam Tip
of Return Better

Benefit Cost Higher is

Ratio Better

Payback Shorter is
Period Better

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