Getting ready for the PMP Exam: Rent versus Buy
Getting ready for the PMP Exam: Rent versus Buy
In a recent blog, Getting ready for the PMP Exam: Contract Risk, I addressed relative procurement risk and the selection of contract types. Within that blog I compared the initiation of procurement with the initiation of a project. In our PMPC preparation course, I regularly emphasize the integration with other knowledge areas and insight that procurement is equivalent to a sub-project. The make-buy decision preceding procurement is equivalent to the cost-benefit analysis that precedes creation of a project charter. In addition to the make-buy decision, you may also be asked to calculate results for a rent (or lease) versus buy decision. Although not specifically identified within A Guide to the Project Management Body of Knowledge 5th Edition®, financial and business calculations are returning to the realm of test worthy content.
You might relate the rent versus buy decision to the Business Analyst’s use of net present value or internal rate of return to determine which projects within a portfolio generate the most financial promise of return. Both net present value, as represented by the following two equations, and Internal Rate of Return were regularly represented on the PMPC® exam until the 4th edition of the PMBOK®.
Net Present Value
In the first equation, PV is present value, FV is future value, I is the interest rate per period, and n is the number of periods.
In the second equation, NPV or net present value is the difference between current principal and the sum of payments over a period of time. The sum of the payments is calculated by dividing the payment amount per period by one plus the interest rate to the power of the number of periods.
Internal Rate of Return
Internal rate of return is merely the interest rate that makes the Net Present Value of an investment over time equal to zero.
The use of Internal Rate of Return (IRR) for business decisions is typically the selection of any project whose Internal Rate of Return exceeds a specific threshold. If, for instance, the company’s IRR on its investments is 12% then any project with a rate of return greater than 12% would yield positive revenue. This would enable the prioritization and selection of projects within a portfolio to justify assignment and creation of a Project Charter.
Both Net Present Value and Internal Rate of Return are related to the time value of money and compounding of interest.
The rent versus buy decision is similar in nature, though for the purpose of the PMP® exam you do not need to take into account compounding.
This would include design, build, operations, support and disposal. For comparison purposes on the exam, you only consider build and operations cost. For a rented or leased item, the cost of the item and operations is covered by the seller (lease provider). For a purchased item, both purchase cost and operations cost must be totaled for an accurate comparison.
As a result, when the cost to rent or lease equals the cost to purchase and operate, the choice is at equilibrium. You need to know how long you actually need the item to determine equilibrium. Remember that projects are temporary and unique. So you would typically want to lease if the rental cost times the number of rental days is less than the purchase price plus operations cost per day.
An equation for the comparison would be:
(Rental cost per day) * number of days = purchase cost + ((daily operations cost) * number of days)
If you understand the concept, you should be able to tackle most questions on the exam without significant math.
Aileen Ellis’ book entitled “How to get every Contract Calculation question right on the PMP® Exam” covers calculations for all the contract types in detail, including 50 sample questions. Although the book focused on calculation of contract terms and values, some of her examples include rent versus buy decisions. The book is available in print or e-book format from Amazon.com for a nominal cost. Here is a link to the print copy. Here is a link to the e-book.
Good luck with your exam prep!
I hope to see you in the classroom, or online!
I will be attending the PMI Global Congress, October 25th -29th. Be sure to check back for blogs reporting on his lessons learned as the Congress progresses.
Steve teaches PMP: Project Management Fundamentals and Professional Certification, Windows 7, Windows 8.1 and CompTIA classes in Phoenix, Arizona.
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