Evaluating mutually exclusive projects with capital budgeting techniques Harvard Case Solution & Analysis

Evaluating mutually exclusive projects with capital budgeting techniques Case Solution

Introduction:

Capital budgeting is a long-term method for financing large infrastructure and industrial projects based on the projected cash flows of the project and to identify the payback period of investment. Financial models can assist how the company values any projects which it is considering and a lot of other terms and calculations to identify different terms of finance. Capital financing is one of the major techniques, which is used by every organization to implement on any project.All financial situations of the company are calculated through the budgeting models.

This case is analyzed by different financial terminologies like NPV, IRR and paybacks periods. This case focuses on the company which has two projects on hand and has to determine, which one to implement. NPV and IRR are well defined and calculated in this case to identify the result. These ratios state the difference between the two projects and calculate the IRR and NPV of both projects through various calculation.

A task was assigned to the newly hired employee in the company to choose the project, which was better from the two and from which the company would be able to get more rate of return and to calculate the present value of each cash flow.This case covers all the financial topics which were required.

1.    Which project is he talking about?

From the analysis of both projects based on the calculations of NPV and IRR, it is determined that Michael is talking about the first project as its IRR is greater than the second project. Michael did calculations through IRR in which the higher internal rate of return is of project 1. Furthermore, Michael was to invest minimum amount and to get maximum profits from it In addition, the provided cash flow of project one is better than that of project two.

Michael’s school colleagues helped him to calculate the projects and then discussed if he wanted any further help regarding any decision. IRR will be high on less investment as compared to other projects because the other projects require more investment and/or are mostly long term projects.

2.    Is IRR an acceptable method to compare two mutually exclusive projects?

The process of selecting capital projects require thorough analysis. Most of the financial evaluation has been determined whether to accept or reject the project. Choosing the correct project can be difficult when a choice must be made between mutually exclusive projects. When projects are mutually exclusive, only one project can be chosen, whereas the others have to be rejected.

IRR is the most accurate method to make a comparison between two mutually exclusive methods. Moreover, IRRis always expressed in percentage. Higher IRR rate project will be selected for the process because higher IRR represents higher return percentage. Sometimes IRR can be a very complex method depending on the timing and variances in cash flows amounts, whereas computer and financials are the main sources of calculating the accurate IRR, as without these sources, it would only be computed on trial and error basis.

There is also a disadvantage of IRR, which is that it should not be used to rate mutually exclusive projects but only to decide whether a single project is worth investing in.

3.    Is NPV an acceptable method when comparing two mutually exclusive projects?

NPV is a better method for evaluating the mutually exclusive project. It employs more realistic reinvestment rate assumptions, is a better indicator of profitability, and mathematically it will return the correct accept-or-reject decision regardless of whether the project experiences non-normal cash flows, or it has differences in project size or timing of cash flow...................

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