Ranking Mutually Exclusive Projects

Tractor Supply - Ranking Mutually Exclusive Projects

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The net gift value and internal rate of return methods yield the same accept or reject rule in case of independent approved investments. However, in real firm situations there are alternative ways of achieving an objective and, thus, accepting one alternative will mean excluding the other. Investment projects are said to be mutually exclusive when only one Investment could be thorough and others would have to be excluded.

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For example, in order to distribute its products a firm may resolve whether to originate its own sales club or engage surface distributors. The more profitable out of the two alternatives shall be selected. This type of exclusiveness may be referred to as technical exclusiveness. On the other hand, two independent projects may also be mutually exclusive if a financial constraint is imposed. If exiguous funds are ready to accept whether task X or task Y, this would be an example of financial exclusiveness or capital rationing. The net gift value and internal rate of return methods can give conflicting ranking to mutually exclusive projects. In the case of independent projects ranking is not prominent since all profitable projects will be accepted. Ranking of projects, however, becomes crucial in the case of mutually exclusive projects. Since the net gift value and internal rate of return rules can give conflicting ranking to projects, one cannot remain indifferent as to the selection of the rule.

Both of these rules will give conflicting ranking to the projects under the following conditions:

• The cash flow pattern of the projects may differ. That is, the cash flows of one task may increase over time, while those of others may decrease of vice verso.

• The cash outlays of the projects may differ.

• The projects may have different predicted lives.

• Reinvestment Assumption and Modified internal rate of return

• The net gift value and internal rate of return rules are sometimes assumed to rest on an underlying implicit assumption about reinvestment of the cash flows generated during the lifetime of the project. It is contented that the source of conflict in the middle of the two techniques lies in their different reinvestment rates.

• The internal rate of return recipe is assumed to imply that the cash flows generated by the task can be reinvestment at its internal rate of return, whereas the net gift value recipe is opinion to assume that the cash flows are reinvested at the opportunity cost of capital. Advocates of the reinvestment assumption reckon concluding values of task to prove their point.

• Net gift value versus Profitability Index

The net gift value and profitability yield same accept or reject rules, because profitability index can be grater than one only when the projects net gift value is positive. In case of marginal projects, net gift value will be zero and profitability index will be equal to one. But a conflict may arise in the middle of the methods if a selection in the middle of mutually exclusive projects has to be made.

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