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- Topic: independent v/s mutually exclusive projects
| Author | Topic: independent v/s mutually exclusive projects |
|---|---|
| bell282 @2010-05-06 13:44:50 |
Can someone explain the difference to me! I could not understand the explanation. |
| slamface @2010-05-08 19:46:14 |
An example of mutually exclusive projects would be the option of a manufacturer to (a) expand its existing plant or (b) build a new one on a separate site in order to increase production capacity. The project that offers the higher NPV and IRR would be picked. Since a firm usually has limited financial resources with substantial opportunity cost, it is not feasible to do both. Hence, these projects are considered mutually exclusive.
Independent projects are ones being evaluated that could potentially all be selected as long as their projected CFs will produce a positive NPV or generate an IRR greater than the firm's hurdle rate. (e.g. a real estate investment co. looking to buy income producing properties) |
| darkcloud @2010-05-27 06:58:18 |
bell282,
With Independent projects, they are evaluated as if you can invest in both projects. Therefore, a project with a positive NPV will also have an IRR higher than the cost of capital. The decision rule for independent projects is the same regardless of the method used to evaluate profitability. For Mutually exclusive projects, you can't take on both projects, you have to chose. When deciding to pick between the projects, the NPV and IRR decision rules (assuming all are profitable) can be in conflict because of time horizon and cash flow differences between the two projects. For example, a short project might have IRR=7% and NPV=10,000 and a long project might have IRR=6% and NPV=20,000. The decision between these projects may be complicated based on the circumstances in which the firm finds itself, but as a general rule, you should pick the project with the higher NPV thereby maximizing firm value. on a side note: NPV is the more conservative decision rule because the process assumes that cash flows are reinvested at WACC rather than at IRR and WACC will be less than IRR for positive NPV projects. |
CFA Discussion Topic: independent v/s mutually exclusive projects
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