MUTUALLY EXCLUSIVE PROJECTS, CAPITAL RATIONING AND MONTE CARLO SIMULATION Presented by – Neha Bhardwaj Vandana Sharma Dheeraj Kaushik Tanu Chaudhary Suneel Kumar
What is is Mutually Mutually What Exclusive Exclusive Projects? Projects?
Meaning: Meaning:
A set set of of projects projects is is mutually mutually •• A exclusive when when only only one one of of the the exclusive set can can be be accepted accepted by by aa firm. firm. set Mutually exclusive exclusive projects projects •• Mutually are the the those those projects projects where where are acceptance of of on on project project acceptance excludes the the acceptance acceptance of of excludes the other other project. project. the
Definition • Mutually exclusive projects are two projects wherein the taking up of one project prevents the taking up of the other project. • It is important for a fund manager to rank these mutually exclusive project based on the return. These rankings are important while making investment decisions.
Examples
• For example: Suppose you have the choice of modifying an existing machine, or replacing it with a brand new one. You could not do both and produce the desired amount of output. Thus, these projects are mutually exclusive. • For example: If there are two machines A and B respectively then A and B are said to be mutually exclusive if the investor decides to invest in machine A he cannot invest in machine B and vice versa.
Example Particulars
Machine A
Machine B
Differential
Cash Inflow
1000
2000
1000
Cost
500
800
300
Net Benefit
500
1200
700
Conclusion Conclusion
In this this case, case, machine machine BB is is In better than than machine machine A. A. better Machine BB is is Rs. Rs. 300 300 Machine costlier than than machine machine A A costlier but it it is is giving giving additional additional but benefit of of Rs. Rs. 1000, 1000, benefit which is is more more than than which additional cost. cost. additional
What is is Capital Capital What rationing? rationing?
Definition
• It means the choice of the investment proposals under the financial constraints of capital expenditure budget. • It is the financial situation in which a firm has only fixed amount to allocate among competing capital expenditure. • The process of allocation of large amount of available funds among number of given proposals is known as capital rationing.
Two stages stages of of Capital Capital Two rationing rationing
Identification Identification of of the the acceptable project project acceptable Selection Selection of of the the combination combination of projects projects of
Selection of of projects projects under under Selection Capital rationing rationing Capital There are are two two type type of of projectsprojectsThere Indivisible Project Project •• Indivisible Divisible Project Project •• Divisible
Example of Indivisible project Budget of firm- Rs. 70 lakh Projects
Initial Investment
NPV ( Rs lakh)
A
10
6
B
24
18
C
32
20
D
22
30
E
18
20
Conclusion Conclusion
NPV from from investment investment D,E D,E and and BB NPV is Rs Rs 64 64 lakh lakh .. is The company company is is advised advised to to invest invest The in D,E D,E and and BB projects. projects. in
What is is Monte Monte What Carlo Carlo simulation? simulation?
Meaning • Monte Carlo simulation is a computerized mathematical technique that allows people to account for risk in quantitative analysis and decision making. • The technique is used by professionals in such widely fields as finance, project management, manufacturing, engineering, research and development, insurance, oil & gas, transportation, and the environment. • The technique was first used by scientists working on the atom bomb; it was named for Monte Carlo, the Monaco resort town famous for its casinos. • It is very useful technique for risk analysis.
Steps in Monte Carlo • Identify the variable that influence cash inflow and outflows • Specify the formula that relate variables • Indicate probability distribution for each variable • Develop a computer program that randomly select one value from the probability distribution of each variable and use these values to calculate the NPV
Advantages Advantages
These are are helpful helpful in in finding finding •• These solution of of complicated complicated solution mathematical expression expression which which mathematical is not not possible possible otherwise. otherwise. is By this this methods methods difficulties difficulties of of •• By trial and and error error experiment experiment are are trial avoided. avoided.
Disadvantages Disadvantages Limited use use because because time time •• Limited consuming. consuming. These are are costly costly way way of of •• These getting aa solution solution of of any any getting problem. problem.