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Project Appraisal - Multiple Projects

Project Appraisal - Multiple Projects

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Published by: api-3757629 on Oct 17, 2008
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03/18/2014

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Multiple Projects and Constraints
Introduction:

When investment proposals are considered individually, any
of the DCF criteria- NPV, IRR, or BCR \u2013 may be applied
for obtaining a correct \u201caccept or reject\u201d signal.
However, in the existing organization, capital investment
projects often cannot be considered individually or in
isolation as project independence, lack of rationing and
project divisibility are rarely fulfilled. So it is proposed to
discuss the problems with the method of ranking, and other
techniques to be employed to select the capital budget in
face of constraints.

13. Constraints:
Projects are economically independent, if the acceptance or
rejection of one does not change the cash flow stream or does
not affect the acceptance or rejection of the other. But, the
projects are dependent, if these conditions are not fulfilled.
Mutually exclusive projects substitutes for each other.

Even though the projects are not mutually exclusive, they
influence negatively each other\u2019s cash flows if they are
accepted together.
Positive economic dependency occurs when there is
complementarity between projects. These can be
asymmetric or symmetric.

Capital Rationing:
When funds available for investment are inadequate to
undertake all projects which are otherwise acceptable,
capital rationing exists. Reasons are:

i ) Internal limitation or external limitation
ii) Set a limit to the capital expenditure outlays
iii) A choice of hurdle rate higher than the cost of

capital of the firm
iv) Inability to raise sufficient amounts of funds
at a given cost of capital.
The implication of rising capital supply is that some
projects would be
postponed or abandoned if the cost of capital tends to increase.
Behaviour of Cost of Capital
Cost of Capital
Quantum of Funds raised

Project Indivisibility:
A capital project has to be accepted or rejected in toto- a
project cannot be accepted or rejected partially.
Given the indivisibility of capital projects and the existence
of capital rationing, the need arises for comparing projects.
An example will illustrate the indivisibility.

Example: A firm is evaluating three projects A, B, and C which have the following data. The funds available to the firm for investment are Rs. 0.7 million.

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