Topic 3: Part 1 Flashcards
Mutual exclusivity
If projects are mutually exclusive, undertaking one project precludes the firm from undertaking the other one.
Eg plot of land
Capital rationing
Capital rationing is the allocation of scarce resources when resources are inefficient to fund all possible projects.
Eg money, supply of skilled labour, time management
Hard rationing
Refers to externally imposed constraints
-one plot of land
Soft rationing
Refers to internally imposed constraints
-management money/budgets/time management/long payback period (PB)
If projects are neither exclusive, no capital constrains
Choose all profitable projects
-projects with NPV>0
Projects are mutually exclusive
We simply wish to maximise NPV
Mutual exclusive and capital constraint
Highest NPV subject to being able to finance it
Only a capital constraint
Project combination with the highest NPV
Scalability
Maintain level of performance at different scales
Replacement chain method
Chain the projects until all possible projects have equal length
Why are uneven project horizons an issue?
- there is no clear cut way of how to judge them
- use replacement chain approach
- chain the projects until all possible projects have equal length
Advantages for linear programming
- can handle multi-period capital constraints where starting one project in one period
- can handle various project constraints
- allows for interpretation of the optimal solution
Disadvantages for linear programming
- requires perfect forecast of when projects are available, their cash flows, and NPV
- also perfect forecast of cost of capital/discount rate for the future
What are the concerns about uneven project horizons?
- does doing something now prevent me from something more profitable in the future?
- short project, can we repeat it?
- variables may change in the future, uncertain
