Multiple Project & Constraint

Project constraints.

Project dependence

Economically independent - Mutually exclusive - Negatively dependent - Positive dependency

Capital Rationing Project Indivisibility

Method of selection

Ranking of the projects

Mathematical programming

Ranking method
1.

Rank all the projects in a decreasing order according to their individual NPVs or IRR Accept budget in the order until capital is exhausted.

2.

Conflict in ranking

Consider a set of five projects A, B, C, D and E for which investment outlay, expected annual cash flow and project life are shown below

Project

Investment outlay

Expected annual cash flow 4,000 10,000 6,000

Project life (years)

A B C

10,000 25,000 30,000

12 4 20

D
E

38,000
35,000

12,000
12,000

16
9

NPV & IRR for the five projects

Project
A B C D E

NPV
14,776 5,370 14,814 45,688 28,936

NPV Ranking 4
5 3 1 2

IRR
39 22 19 30 29

IRR Ranking 1
4 5 2 3

Project indivisibility The capital to be employed Rs 2,500,000

Project A Outlay 1,500,000 NPV 400,000

B
C D E

1,000,000
800,000 700,000 600,000

350,000
300,000 300,000 250,000

Feasible combination approach

Define all combinations of project which are feasible, given the capital budget restriction and project interdependencies. Choose the feasible combination that has the highest NPV

A firm which has a capital budget constraint of Rs 3,000,000

Project A Outlay 1,800,000 NPV 750,000

B
C D E

1,500,000
1,200,000 750,000 600,000

600,000
500,000 360,000 300,000

Feasible combination A B C D E A and C A and D A and E

Outlay 1,800,000 1,500,000 1,200,000 750,000 600,000 3,000,000 2,550,000 2,400,000

NPV 750,000 600,000 500,000 360,000 300,000 1,250,000 1,110,000 1,050,000

B and D
B and E C and D C and E B,D and E C,D and E

2,250,000
2,100,000 1,950,000 1,800,000 2,850,000 2,550,000

960,000
900,000 860,000 800,000 1,260,000 1,160,000

Mathematical Programming approach

1. 2.

It is formulated in terms of two broad categories of equations The objective function The constraint equation The mathematical model seeks to optimize the objective function subject to various constraint

Mathematical Programming Models

Linear programming Integer programming Goal programming

Linear Programming Model cash outflow in 1st period cannot be more than 50 cash outflow in 1st period cannot be more than 20
Project 1 2 3 NPV 14 17 17 Cash outflow in period 1 12 54 6 Cash outflow in period 2 3 7 6

4 5 6 7 8 9

15 40 12 14 10 12

6 30 6 48 36 18

2 35 6 4 3 3

Consider a firm which is evaluating seven projects with following characteristics the budget available to the firm is restricted to 35 in year 1 and 30 in year 2 Project NPV Cash outflow in period 1 Cash outflow in period 2

1 2 3 4 5 6 7

6 8 8 7 4 12 9

5 9 12 3 4 10 13

7 5 4 10 6 15 9

There are two additional constraint Project 1 2 3 4 5 6 7 Power requirement Managerial requirement 2 6 4 5 3 4 7 6 <= 18 5 7 2 4 8 3 <= 20