Independent and Mutually Exclusive Projects
Understanding of classification of capital budgeting projects plays a crucial role while analyzing viability of projects.
What is mutually Independent Projects?
A Project whose cash flows have no impact on the acceptance or rejection of other projects is termed as Independent Project (not mutually exclusive). Thus, all such Projects which meet this criterion should be accepted.
What is mutually exclusive Projects?
A set of projects from which at most one will be accepted is termed as Mutually Exclusive Projects. In mutually exclusive projects, cash flows of one project can be adversely affected by the acceptance of the other project. In mutually exclusive projects, all projects are to accomplish the same task. Therefore, such projects cannot be undertaken simultaneously. Hence, while choosing among Mutually Exclusive Projects, more than one project may satisfy the Capital Budgeting criterion. However, only one project can be accepted.
Which project should be accepted depends on different factors like initial investment, time period required for completion, strategic importance of the project, etc. usually the project which adds more value to the business in the long run will be selected.
Capital budgeting techniques give same acceptance or rejection decisions regarding independent projects but conflict may arise in case of mutually exclusive projects. If conflicts arise while making decision regarding mutually exclusive projects, the Net Present Value method should be given priority due to its more conservative or realistic reinvestment rate assumption. The Net Present Value and Internal Rate of Return, both methods are superior to the payback period, but Net present Value is superior to even Internal Rate of Return.