University of Bahrain

College of Engineering
Department of Mechanical Engineering

CHAPTER 12 MENG 300

S2 , 2022 / 2023

Independent Projects
with Budget Limitation
Dr.Saraa Al-asadi
salasadi@uob.edu.bh

by Qas Alasadi
Purpose Learning Sections
Outcomes

Chapter Tutorial
Summary Session
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Purpose

Select independent
projects for funding
when there is a
limitation on the
amount of capital
available for
investment.
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Page 02 of 15
 Learning Outcomes
TOPIC SECTION OUTCOME

Capital Explain how a capital budgeting problem

rationing
12.1 is approached.

Use PW-based capital budgeting to

Equal-life 12.2 select from several equal-life
projects independent projects.

Use PW-based capital budgeting to

Unequal-life
projects 12.3 select from several unequal-life
independent projects.
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 12.1 An Overview of Capital Rationing
among Projects
A capital budgeting study has the following characteristics
The service provided will be needed over the entire LCM
years or more.

Each project is either selected
entirely or not selected; that is,
partial investment in a project
is not possible.
1
2 4 constraints may be present for
the first year only or for several
years. This investment limit is
identified by the symbol b.

A stated budgetary constraint 3 5 The objective is to maximize the

return on the investments using
restricts the total amount available
a measure of worth, such as the
for investment. Budget
PW value.
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 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects
The procedure to conduct a capital budgeting study using
PW analysis is as follows:

1 Drop projects beyond budget Drop bundles beyond budget 4

2 Drop projects with negative NPV Select bundle with max NPV 5
Create bundles (bundles = 𝒎 ,
3 m : number of alternatives),
Re-invest in MARR if there is
available budget 6
Include Do Nothing as a bundle
 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects
If the investment limit is b= $25,000, find the viable
bundles

Consider these projects Viable bundles

 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects
EXAMPLE 12.1
The projects review committee of Microsoft has $20 million to allocate next year to new
software product development. Any or all of five projects in Table 12–1 may be accepted.
All amounts are in $1000 units. Each project has an expected life of 9 years. Select the
project(s) if a 15% return is expected. b = $ 20,000,000
 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1

STEP 1 : Drop projects beyond budget

Project Initial NCF Life NPV Comment
investment
A −10,000 2870 9

B −15,000 2930 9

C −8,000 2680 9

D −6,000 2540 9

E −21,000 9500 9 Reject Beyond Budget

 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1

STEP 2 : Drop projects with negative NPV

PwA = -10,000 + 2,870 (P/A, 15%, 9) = + 3,694

PwB = -15,000 + 2,930 (P/A, 15%, 9) = −1,019

PwC = -8,000 + 2680 (P/A, 15%, 9) = + 4,788

PwD= -6,000 + 2,540 (P/A, 15%, 9) = +6,120

 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1

STEP 2 : Drop projects with negative NPV

Project Initial NCF Life NPV Comment
investment
A −10,000 2870 9 + 3,694

B −15,000 2930 9 −1,019 Reject –ve NPV

C −8,000 2680 9 + 4,788

D −6,000 2540 9 +6,120

E −21,000 9500 9 Reject Beyond Budget

 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1

STEP 3 : Create bundles (bundles = ^ = 2 ^3 = 8 )

Project Initial NCF Life NPV Comment
investment
1 A −10,000 2870 9 + 3,694

B −15,000 2930 9 −1,019 Reject –ve NPV

2 C −8,000 2680 9 + 4,788

3 D −6,000 2540 9 +6,120

E −21,000 9500 9 Reject Beyond Budget

 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1
STEP 3 : Create bundles (bundles = ^ = 2 ^3 = 8 )
Project Initial NCF Life NPV Comment
investment
1 A −10,000 2870 9 + 3,694
B −15,000 2930 9 −1,019 Reject –ve NPV
2 C −8,000 2680 9 + 4,788
3 D −6,000 2540 9 +6,120
E −21,000 9500 9 Reject Beyond Budget
4 AC −18,000 9,9 +8,482
5 AD −16,000 9,9 +9,814
6 CD −14,000 9,9 +10,908
7 ACD -24,000 9,9 +14,602
8 D.N. - - - -
 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1
STEP 4 : Drop bundles beyond budget
Project Initial NCF Life NPV Comment
investment
1 A −10,000 2870 9 + 3,694
B −15,000 2930 9 −1,019 Reject –ve NPV
2 C −8,000 2680 9 + 4,788
3 D −6,000 2540 9 +6,120
E −21,000 9500 9 Reject Beyond Budget
4 AC −18,000 9,9 +8,482
5 AD −16,000 9,9 +9,814
6 CD −14,000 9,9 +10,908
7 ACD -24,000 9,9 +14,602 Reject Beyond Budget
8 D.N. - - - -
 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1
STEP 5 : Select bundle with max NPV
Project Initial NCF Life NPV Comment
investment
1 A −10,000 2870 9 + 3,694
B −15,000 2930 9 −1,019 Reject –ve NPV
2 C −8,000 2680 9 + 4,788
3 D −6,000 2540 9 +6,120
E −21,000 9500 9 Reject Beyond Budget
4 AC −18,000 9,9 +8,482
5 AD −16,000 9,9 +9,814
6 CD −14,000 9,9 +10,908 SELECTED
7 ACD -24,000 9,9 +14,602 Reject Beyond Budget
8 D.N. - - - -
 12.2 Capital Rationing Using PW Analysis
of Equal-Life Projects EXAMPLE 12.1
STEP 6 : Re-invest in MARR if there is available budget
Project Initial NCF Life NPV Comment
investment
6 CD −14,000 9,9 +10,908 SELECTED

Left Over Budget = 20,000,000 – 14,000,000

= $ 6,000,000

to be re-invested at the MARR 15% per year for 9 Years

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 12.3 Capital Rationing Using PW Analysis of
Unequal-Life Projects
EXAMPLE 12.2
For MARR = 15% per year and b = $20,000, select from the following
independent projects. Solve by hand

b = $ 20,000
 12.3 Capital Rationing Using PW Analysis of
Unequal-Life Projects
EXAMPLE 12.2
Project Initial NCF Life NPV Comment
investment
1 A −8,000 3870 6 +6,646
B −15,000 2930 9 −1,019 Reject –ve NPV
2 C −8,000 2680 5 +984
D −8,000 2540 4 −748 Reject –ve NPV
3 AC −16,000 5,6 +7,630 SELECTED
4 D.N. - - - -

Left Over Budget = 20,000 – 16,000

= $ 4,000

To be re-invested at the MARR 15% per year for 6 Years

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