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Multiple Projects and Constraints

When handling multiple projects simultaneously, an organization must consider more than just schedules - it also faces multiple risks, stakeholders, and managers allocating limited resources. Projects may be dependent on each other and the available capital is rationed. Furthermore, projects often cannot be divided up and must be fully accepted or rejected. These constraints of dependence, rationing, and indivisibility mean that evaluating projects individually using discounted cash flow metrics like NPV may lead to incorrect decisions. The organization must compare projects holistically under the real-world constraints.

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3K views

Multiple Projects and Constraints

When handling multiple projects simultaneously, an organization must consider more than just schedules - it also faces multiple risks, stakeholders, and managers allocating limited resources. Projects may be dependent on each other and the available capital is rationed. Furthermore, projects often cannot be divided up and must be fully accepted or rejected. These constraints of dependence, rationing, and indivisibility mean that evaluating projects individually using discounted cash flow metrics like NPV may lead to incorrect decisions. The organization must compare projects holistically under the real-world constraints.

Uploaded by

Hamza
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Multiple projects refers when handling several projects at once means more than dealing with

just multiple schedules, it involves multiple risks, multiple stakeholders and multiple functional
managers who allocate resources.

In existing organizations capital investment decisions can’t be taken in isolation due to lack of
capital rationing and project independence. Without considering the constraints, the rational
criterion of project evaluation (NPV, IRR, etc) may lead to wrong decisions.

When investment projects are considered individually, any of the discounted cash flow
technique may be applied for obtaining a correct accept or reject criteria. In an existing
organisation, however, capital investment projects often cannot be considered individually or in
isolation. This is because the pre-conditions for viewing projects individually- project
independence, lack of capital rationing, and project divisibility are rarely, if ever, fulfilled. Under
the constraints obtained in the real world, the so-called rational criteria per se may not
necessarily signal the correct decision.

Constraints:
● Project dependence
● Capital rationing
● Project indivisibility

Project dependence:
Project A and B are said to be economically independent if acceptance or rejection of
one does not affect the cash flow of other or does not affect acceptance or rejection of other.
(Ex. Investment in power press and investment in computer installation are independent). While
on other hand projects A and B are economically dependent if the acceptance or rejection of
any one changes the cash flow stream of the other or affects the acceptance or rejection of the
other. If selection of Project A would lead to the decision of opting out from project B or vice
versa, both of these projects A and B are considered as mutually exclusive projects where
selection of one project would result in rejection of the other because the purpose of both
projects would be same but might be in different way. For example semi-automatic plant versus
automatic plant.

Capital rationing:
Capital rationing exists when capital available is insufficient to undertake all projects
which are else acceptable. Capital rationing may arise because of internal limitations or external
constraints. Internal capital rationing is caused by management's decision to set a limit on
capital expenditure outlays whereas external capital rationing arises out of a firm's inability to
raise sufficient fund at a given cost of capital.

Project indivisibility:
Capital projects are considered indivisible means a capital project has to be either
accepted or rejected so it cannot be accepted partially. Ex. Three indivisible projects X, Y and Z
require investment of Rs 5 million, 4 million and 3 million. NPV of the projects are 2 million, 1.5
million and 1 million respectively. Total funds available to firm for investments are 7 million.
Based on the criteria of NPV Project X is superior. But in this situation acceptance of X with
NPV of 2 million will make rejection of Y and Z due to capital rationing, which together provides
NPV of 2.5 million. Hence because of indivisibility of projects, there is need for comparing
projects before the acceptance or rejection decisions are made.

Comparing projects under constraint:


Ranking Conflicts In a given set of Projects, preference ranking tends to differ from one criterion
to other criterion. For example NPV and IRR criteria may yield different preference rankings
similarly preference ranking conflict may arise between NPV and BCR methods. When
preference rankings differ, the set of projects selected as per one approach tends to differ from
set of projects selected on the basis of another approach.

Conflicts in project ranking may arise because of


● Size disparity
● Time disparity
● Life disparity

Size disparity: Size of the capital projects may tremendously differ ( NPV refers to size while
IRR and B/C ratio does not refers to size of capital).

Time disparity: due to varying pattern of cash inflows ( IRR assumes that cash inflows can be
reinvested at the same rate or return while NPV and B/C ratio analysis assumes that cash
inflows can be reinvested at the firms cost of capital). It may be solved by defining reinvestment
rate.

Life disparity: When mutually exclusive alternatives have different project life. This conflict can
be taken care by defining reinvestment rate.

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