TOPIC: Free PMP® Exam Sample Question

A project manager is developing a cost management plan and needs to determine the best source of funding for a project that is dictated by a legal requirement. The cost of capital is estimated at 9.7% for non-dividend paying equity, 6.7% for debt, and 5.1% for self-funding. The NPV of the project is $500,000, and the opportunity cost is $750,000.

What is the project manager's best course of action?

A. Fund the project with equity since there are no dividend obligations
B. Select the self-funding option since it provides the lowest cost of capital
C. Perform an alternatives analysis since there are multiple factors to consider
D. Recommend the termination of the project since another project has a higher NPV

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HINT: What tool or technique associated with the Plan Cost Management process might be helpful in this situation?

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Answer and Explanation:
The correct answer is C.

The question states that the project manager is developing the cost management plan, which indicates that the Plan Cost Management process is being performed.

A data analysis technique that can be used for this process includes an alternatives analysis, which is a technique used to evaluate identified options in order to select the options or approaches to use to execute and perform the work of the project.

In this case, an alternatives analysis can consist of reviewing funding options such as self-funding, funding with equity, or funding with debt. Even though the question provides some financial data, there are other factors that should be taken into consideration before selecting the appropriate source of funding.

Therefore, among the available options, the best course of action for the project manager is to perform an alternatives analysis.

Details for each option:

A. Incorrect. Dividend payments are only one aspect of the cost of capital for equity. The estimated cost of capital for equity is provided by the question at 9.7%. Equity may or may not be the best source of funding, and the project manager should first perform data analysis to make that determination.

B. Incorrect. The self-funding option does provide the lowest cost of capital, and this is one factor for consideration in the selection of the funding source(s). However, the cost of capital is not the only factor that should be considered. Does the company have the capital available? If so, what will be the impact of lowering the company's cash reserves? Even though the self-funding option is the least expensive option, it may not be the best source of funding. The project manager, likely in collaboration with the finance department, will first need to perform data analysis in order to select the best source of funding.

C. Correct. Alternatives analysis can consist of reviewing funding options such as self-funding, funding with equity, or funding with debt. Even though the question provides some financial data, there are other factors which should be taken into consideration before selecting the appropriate source of funding.

D. Incorrect. The question states the project has a net present value (NPV) of $500,000 with an opportunity cost of $750,000. Opportunity cost represents the value of the opportunity not selected. The project with the greater NPV of $750,000 would be more profitable for the company. However, the question also states that the current project "is dictated by a legal requirement." Hence, regardless of the NPV, the project in the subject is not optional, and, therefore, recommending its termination is unlikely to be the best course of action.

Reference: A Guide to the Project Management Body of Knowledge (PMBOK^® Guide) – Sixth Edition, Project Management Institute Inc., 2017, Page(s) 34, 78, 238