- Independent projects – if the cash flows of one are unaffected by the acceptance of the other.
- Mutually exclusive projects
– if the cash flows of one can be adversely impacted by the acceptance of the other.
Projects are said to be independent if the accept/reject
decision does not have any impact on the accept/reject decision of other projects. Projects
are said to be mutually exclusive if the acceptance of one project has any consequence
upon the decision of another project. The latter case is the most often seen as firms decide among several comparable options
but is only going to select one of the options.
The NPV and IRR methods make the same accept/reject decisions for independent projects, but if
projects are mutually exclusive, then ranking conflicts can arise. If conflicts arise, the NPV method should be used due to
the more conservative or realistic reinvestment rate assumption. The NPV and IRR methods are both superior to the payback,
but NPV is superior to IRR.
Instead of calculating the MIRR, calculate both the NPV and IRR for each project. Practice setting the problems up using the formula and then using your calculator
to find the NPV and IRR. The NPVX=$58.02 and IRRX=14.11%. The NPVY=$39.94 and IRRY=15.62%.
Project X has a higher NPV but Project Y has a higher expected rate of return.
The conflict is a result of the reinvestment rate assumption. Select Project
X because it adds more value to the company.