FINMA REPORTING SCRIPT

A. INDEPENDENT VS MUTUALLY EXCLUSIVE PROJECTS

Most investments can be placed into one of two categories:
1. Independent Projects
 Independent (sometimes called stand-alone) projects are any set of projects in which
choosing one has no impact on our decision to choose another project from that set.
For short, the word “independent” means “unrelated, unattached or separate”.
 Taking one project does not influence the other, so they are independent. When we
have independent projects, our decision rule does not need to rank which project is the
best, but merely identify if the project is good or bad.
 For example, McBurger Inc. may have the following capital budgeting projects to
consider. The first is a new deep frying system for their french fries. The second is a
new order placement system for the drive-thru. McBurger could choose to take the new
deep fryer or the new order placement, or it could choose both.
2. MUTUALLY EXCLUSIVE PROJECTS
 The acceptance of one eliminates from further consideration all other projects that
serve a similar function.
 This means two or more events that cannot happen simultaneously. It is commonly used
to describe a situation where the occurrence of one outcome supersedes the other.
 The time value of money (TVM) is often considered when deciding between two
mutually exclusive choices.
 Unlike independent projects, in which a decision to invest in one project has no bearing
on the decision to make investment in another, investment decision in case of mutually
exclusive projects is dependent on the relative merit of the projects.
 For example, assume a company has a budget of $50,000 for expansion projects. If
available Projects A and B each cost $40,000 and Project C costs only $10,000, then
Projects A and B are mutually exclusive. If the company pursues A, it cannot also afford
to pursue B and vice versa. Project C may be considered independent. Regardless of
which other project is pursued, the company can still afford to pursue C as well. The
acceptance of either A or B does not impact the viability of C, and the acceptance of C
does not impact the viability of either of the other projects. EXPLAIN THE TABLE.
B. UNLIMITED FUNDS VS. CAPITAL RATIONING
1. Unlimited Funds
 It is the financial situation in which a firm or a company is able to accept all
independent projects that provide an acceptable return.
 All independent projects that will provide an acceptable return can be accepted.
2. Capital Rationing
 It is the act of placing restrictions on the amount of new investments or projects
undertaken by a company. This is accomplished by imposing a higher cost of capital for
investment consideration or by setting a ceiling on specific portions of a budget.
 The goal of capital rationing is to ensure that money is allocated to its best use and to
ensure that the enterprise will not run short of cash.
We’d also have to take note that the availability of funds for capital expenditures
affects the firm’s decisions.
 For example, suppose ABC Corp. has a cost of capital of 10% but that the company has
undertaken too many projects, many of which are incomplete. This causes the company's
actual return on investment to drop well below the 10% level. As a result, the management
decides to place a cap on the number of new projects by raising the cost of capital for these
new projects to 15%. In addition to that, starting fewer new projects would give the
company more time and resources to complete existing projects.
C. ACCEPT-REJECT VS. RANKING APPROACH
There are two basic approaches to capital budgeting decisions:
1. Accept-Reject Approach
▫ A determination is made as to whether or not a project meets some minimum
acceptance criteria. If so, if is accepted; if not, it is rejected. In these cases, only
acceptable projects should be considered.
▫ This approach can be used when the firm has unlimited funds, most likely when
evaluating mutually exclusive projects, or in a situation in which capital must be
rationed.
2. Ranking Approach
 The ranking approach involves ranking projects on the basis of some predetermined
measure, such as the rate of return.
 Here we list projects' rates of return from highest to lowest. A determination is then
made as to which projects make the "cut."  Here an independent or mutually exclusive
situation must be considered.
In the ranking approach, the progress of the project and the rate of return is highly
considered.
TABLE:

A firm with unlimited funds must evaluate seven projects, A through G, for
its upcoming planning cycle.

Answer: A ranking of the projects is G, B, E, and A.  

Explanation: Since projects C, D, E, and F are mutually exclusive, the highest return of this
four is taken (E). The others are rejected. All independent projects can be chosen since they
do not compete with each other. Note that no decision on which of the four acceptable
projects can be made at this time since we do not have information on the firms cost of
capital.