MULTIPLE PROJECTS

Presented By:Nidhi Neha Shivang Nitesh amit

Topics Covered
Project Dependence

Capital Rationing

Ranking Methods Of Project

Types of Project
There are basically three types of projects: Dependent Projects- A project that is dependent upon
any other project is known as dependent project. Acceptance of a project is contingent on the acceptance of another project.

Independent Projects- A project that is not part of or

dependent on any other project. Thus, the funding of an independent project does not depend on another project funding.

Mutually Exclusive- Mutually exclusive projects means

that the acceptance of one project eliminates the others from consideration. Hence they are two projects wherein the taking up of one project prevents the taking up of the other project.

CONSTRAINTS
Project Dependence
Two projects are economically independent if the acceptance or rejection of one does not change the cash flow stream of the other or does not affect the acceptance or rejection of the other. On the other hand two projects are economically dependent if the acceptance or rejection of one changes the cash flow stream of the other or affects the acceptance or rejection of the other.

Types of economic dependency occurs when:

Projects are mutually exclusive: acceptance of any one project out of the set of mutually exclusive projects automatically precludes the acceptance of all other projects in a set Projects are not mutually exclusive: when projects even though not mutually exclusive, negatively influence each others cash flow if accepted together Positive economic dependency: it occurs when there is complementarity between projects

 Capital Rationing It exists when funds available for

investment are inadequate to undertake all projects which are otherwise acceptable.

Sources of capital rationing:

Internal External
Project indivisibility - Capital projects are considered indivisible ie, it has to be accepted or rejected-it cannot be accepted partially

illustration
To illustrate this point consider an example Firm is evaluating three projects Total funds available-7million PROJECTS
A B C

OUTLAY
5 4 3

NPV
2 1.5 1

Solution:- In this situation, acceptance of project A ( projects with the highest net present value ) which yields a net present value of Rs. 2 million resulted in the rejection of projects B and C which together would yield a combined net present value of Rs. 2.5 million. Hence, because of the indivisibility of projects, there is a need for comparing projects before the acceptance/ rejection decisions are taken.

Methods Of Ranking
Because of economic dependency ,capital rationing and project indivisibility a need arises for comparing projects in order to accept some and reject other. There are two approaches available: The method of ranking The method of mathematical programming

Steps in Method Of Ranking

1) Rank all projects in a descending order according to their individual NPVs, IRRs 2) Accept projects in that order until the capital budget is exhausted.

Problems
A. Conflicts in Ranking- In a given set of projects, preference ranking tends to differ from one criterion to another. Sources: Size disparity: conflict may occur because of the disparity in the size of initial outlays. Time disparity: Projects may differ with respect to the sequence of the pattern od cash inflows associated with them. Life disparity: In some cases the mutually exclusive alternatives have varying lives.

 Size disparity
To illustrate such conflict consider two mutually exclusive projects A and B ,being analyzed by firm whose cost of capital is 10%. project A project B Original investment 400000 1600000 Cash inflow per year 100000 300000 Useful life 10 yrs 10yrs NPV and IRR for both the projects have been shown below: project A project B NPV 2,14,460 2,43,380 IRR 22% 13%

Time disparity Projects may differ with respect to sequence of pattern of cash inflows associated with them. such time disparity of cash inflows may lead to conflicts in ranking. Here are two projects X and Y being evaluated at a given cost of capital 10%. Project X project Y Initial outlay 110000 110000 Cash inflows Year1 31000 71000 Year2 40000 40000 Year3 50000 40000 Year4 70000 20000

 The NPV and IRR of these projects are shown below: Project X project Y NPV 36613 31314 IRR 22% 25%

 Life disparity
Consider two projects P and Q being evaluated at a given cost of capital 12%. Project P project Q Initial outlay 200000 200000 Cash outlays Year1 300000 80000 Year2 80000 Year3 280000 NPV IRR 67857 50% 134512 50%

Illustration
Consider two mutually exclusive projects, A and B, being analysed by a firm whose cost of capital is 10% . Project A B Project is having limited Project availability of
Original investment Rs. 400000 Cash flow per year Rs. 100000 Rs.1600000 Rs. 300000

Usefiul life

10 years

10 years

B) Project indivisibility A problem in choosing the capital budget on the bass of individual ranking arises because of indivisibility of capital expenditure projects.

Feasible combination approach

STEPS: Define all combinations of project which are feasible given the capital budget ,restriction and project interdependence. Choose the feasible combination that has the highest NPV.

Example:
Capital budget of Rs 3000000 Project B and C are mutually exclusive , other Project outlay NPV projects are independent
A B C D E 1800000 1500000 1200000 750000 600000 750000 600000 500000 360000 30000

 Given the information, the feasible combinations and their NPVs are shown below:
Feasible combination A B C D E A and C A and D A and E B and D B and E C and D Outlay 1800000 1500000 1200000 750000 600000 3000000 2550000 2400000 225000 2100000 1950000 NPV 750000 600000 500000 360000 30000 1250000 1110000 1050000 960000 900000 860000

Feasible combination C and E B, D and E C, D and E

Outlay 1800000 2850000 2550000

NPV 800000 1260000 1160000

The most desirable feasible combination consists of projects B, D and E as it has the highest NPV

Thank You