Evaluation of Independent Projects

 

Consider a biomedical company that has a new genetics engineering product that it can market in three different countries (S, U, and R), including any combination of the three. The do-nothing (DN) alternative is also an option. All possible options are: S, U, R, SU, SR, UR, SUR, and DN. In general, for m independent projects, there are 2m alternatives to evaluate. Selection from independent projects uses a fundamentally different approach from that for mutually exclusive (ME) alternatives. When selecting independent projects, each project’s PW is calculated using the MARR. (In ME alternative evaluation, the projects compete with each other, and only one is selected.) The selection rule is quite simple for one or more independent projects:

Select all projects that have PW ≥ 0 at the MARR.

All projects must be developed to have revenue cash flows (not costs only) so that projects earning more than the MARR have positive PW values.

Unlike ME alternative evaluation, which assumes the need for the service over multiple life cycles, independent projects are considered one-time investments. This means the PW analysis is performed over the respective life of each project and the assumption is made that any leftover cash flows earn at the MARR when the project ends. As a result, the equal service requirement does not impose the use of a specified study period or the LCM method. The implied study period is that of the longest lived project.

There are two types of selection environments—unlimited and budget constrained.

§  Unlimited. All projects that make or exceed the MARR are selected. Selection is made using the PW ≥ 0 guideline.

§  Budget constrained. No more than a specified amount, b, of funds can be invested in all of the selected projects, and each project must make or exceed the MARR. Now the solution methodology is slightly more complex in that bundles of projects that do not exceed the investment limit b are the only ones evaluated using PW values. The procedure is:

1. Determine all bundles that have total initial investments no more than b. (This limit usually applies in year 0 to get the project started).

2. Find the PW value at the MARR for all projects contained in the bundles.

3. Total the PW values for each bundle in (1).

4. Select the bundle with the largest PW value.