Mutually Exclusive Investments ©Dr. Bradley C. Paul 2002 revised 2009 Note – The concepts covered in these slides can be found in numerous sources dealing with engineering economics and is therefore considered common knowledge by the author of these slides.

Comparative Investment Techniques  For alternatives of similar magnitude  NPV good index  Is scale sensitive  For Portfolio Investing  Economic Efficiency Indicators  IRR for a slash and burn (fluid portfolios)  PVR for max efficiency in a fixed business line  Sometimes picking one investment means not picking another  Implied in bang for the buck investing is that you will be choosing from a wide array of unrelated decisions.

The Mutually Exclusive Problem  Investments of different size and significant money not involved will either not be invested or invested at some standard rate  What if deciding to pursue one investment automatically changes the universe of other decisions available  Example – when something is mutually exclusive.

Illustrate the Problem  You have $10,000,000 to invest.  You can invest microchips for specialized space shuttle computers  Get PVR of 3.15  Max investment $50,000  You can set up your microchip firm to make gas mileage chips for cars  PVR is 1.92  Max investment $9,950,000  You can’t make your company do both things  Money you don’t invest in the buisiness goes into a general stock fund at PVR 1

Straight PVR investor locks onto the high return  Problem is that he made two decisions and only planned for one  NPV for whole portfolio  $50,000 at 3.15 is PV of $157,500  $9,950,000 at 1 PV is 9,950,000  $10,107,500  Other choice  $950,000 at PVR 1.92 is $19,104,000  $50,000 at PVR 1 is $50,000  Total $19,154,000

Point  Mutually exclusive picks link decisions together  Need to look at the financial results of the package  Not just lock onto one return number

Net Future Value Solution  Take block of money to be invested  Put appropriate amount into each investment  Put the rest into default investment (which could be no investment at all)  Pick an appropriate target time frame for comparison  Do NFV (or NFW for the books terms) on all the alternatives  See which choice gives you the richest portfolio in the end

Advantages of NFV  It can compare multiple mutually exclusive alternatives – not just two  It directly measures the bottom line which is what you wanted to maximize anyway  It won’t blow-up with an unconventional cash flow like an IRR could  It doesn’t require standing on your head and drinking a glass of water to decide what it means