St.

Mary's University

Department of Marketing Management

Assignment of Project management

Prepared by :- israel addisu

Submitted to :- Daniel
M.Gebremariam
1.Capital rationing is the strategy of picking up the most profitable projects to invest the available funds.
Hard capital rationing and soft capital rationing are two different types of capital rationing practices
applied during capital restrictions faced by a company in its capital budgeting process. In the efficient
capital markets, a company’s aim is to maximize the shareholder’s wealth and its value by investing in all
profitable projects. However, in real life, a company may realize that the internal and the external funds
available for new investments may be limited.Definition of Hard and Soft Capital Rationing

There are two situations which may lead to capital rationing, namely hard and soft capital rationing.
Hard capital rationing or “external” rationing occurs when the company faces problems in raising funds
in the external equity markets. This can lead to the shortage of capital to finance the new projects in the
company.On the other hand, soft capital rationing or “internal” rationing is caused due to the internal
policies of the company. The company may voluntarily have certain restrictions that limit the number of
funds available for investments in projects. However, these restrictions can be modified in the future;
hence, the term ‘soft’ is used for it.

2.Conflict due to size of a project

Project A needs $10 million investment and generates $10 million each in year 1 and year 2. It has NPV
of $7.4 million at a discount rate of 10% and IRR of 61.8%.

Project B needs $1 million investment and generates $2 million in Year 1 and $1 million in Year 2.

1. Its NPV at a discount rate of 10% and IRR turn out to be $1.6 million and 141.4% respectively.

Based on NPV one would conclude that Project A is better, but IRR offers a contradictory view. This
conflict arose due to the size of the project. In the end, we should go with the NPV recommendation.

2. Consider a set of 5 projects, A,B,C,D and E, for which the investment outlay, expected annual
cashflow, and project life are as shown below:

Project Investment outlays Expected annual cash Project life(year)

A 50,000 20,000 8

B 76,000 24,000 32

C 70,000 24,000 18

D 60,000 12,000 40

E 20,000 8,000 24

- NPV, IRR and BCR for the five projects

A 10,740 5 44 4 2.42 5

B 91,376 1 60 2 4.40 2

C 57,872 2 58 3 3.66 3

D 29,628 3 38 5 2.98 4

E 29,552 4 78 1 4.96 1

3.to decision making with multiple criteria. In the goal procedures, the user identifies a goal (a preferred
combination of criterion values), and then a related decision is computed.

Consider the following projects that are being evaluated by a firm which has a capital budget constraints
of ETB 1,500,000

Project Investment outlay(ETB) NPV(ETB)

A 900,000 375,000

B 750,000 300,000

C 600,000 250,000

D 375,000 180,000

E 300,000 150,000

project B&C are mutually exclusive. Other projects are independent. Given the above information the
feasible combinations and there NPV are shown below

Project Investment outlays (ETB) NPV(ETB)

A 900,000 375,000

B 750,000 300,000

C 600,000 250,000

D 375,000 180,000

E 300,000 150,000

A&C 1,500,000 625,000

A&D 1,275,000 555,000

A&E 1,200,000 525,000

B&E 1,050,000 450,000

C&D 975,000 430,000

C&E 900,000 400,000

B,D,&E 1,425,000 630,000

C,D,&E 1,275,000 580,000

the most desirable feasible combination consists of project B,D,&E as it has the highest NPV.

4.The use of linear functions implies the following assumptions about the LP model:

1) Proportionality

The contribution of any decision variable to the objective function is proportional to its value.For
example in the diet problem, the contribution to the cost of the diet from one pound of apples is $0.75,
from two pounds of apples its $1.50 and from four pound the contribution is $3.00. For four hundred
pounds, the contribution would be $300.00. In many situations, you might get a volume discount such
that the price per pound goes down if you purchase more apples. These discounts are often nonlinear,
which that a linear programming model is either inappropriate or is really an approximation of the real
world problem.

2) Additivity

The contribution to the objective function for any variable is independent of the other decision
variables. For example in the NSC production problem, the production of P2 tons of steel in Month 2 will
always contribute $4000 P2 regardless of how much steel is produced in Month 1.

Proportionality and Additivity are also implied by the linear constraints. In the diet problem, you can
obtain 40 milligrams of protein for each gallon of milk you drink. It is unlikely, however, that you would
actually obtain 400 milligrams of protein by drinking 100 gallons of milk. Also, it may be the case due to
a chemical reaction, you might obtain less than 70 milligrams of Vitamin a by combining a pound of
cheese with a pound of apples. Thus, the LP model is really just an approximation of what really
happens.

3) Divisibility

Since we are using continuous variables, the LP model assumes that the decision variables can take on
fractional variables. Thus, we could a solution to the GT Railroad problem that sends 0.7 locomotives
from Centerville to Fine Place. In many situations, the LP is being used on a large enough scale that one
can round the optimal decision variables up or down to the nearest integer and get an answer that is
reasonably close to the optimal integer solution. For example, if an LP for a production plan said to
produce 12,208.4 widgets, we can be probably produce 12,209 and be close to an optimal solution. As
we will discuss later in the semester, problems in which some or all the variables must be integers are
generally speaking much hard to solve than LPs.

Divisibility also implies that the decision variables can take on the full range of real values. For example,
in the tennis problem, the LP may tell you bet $19.123567 on player A to win the match. Again, most of
the problems we will encounter in this course are on a large enough scale that some rounding or
truncating of the optimal LP decision variables will not greatly affect the solution.

4) Certainty

The LP model assumes that all the constant terms, objective function and constraint coefficients as well
as the right hand sides, are know with absolute certainty and will not change. If the values of these
quantities are known with certainty, for example the demand data given in the NSC may be forecasts
that might not be 100% accurate, then this assumption is violated.

5.integer linear programming was developed for the class of problems where fractions are not allowed.
The most basic of these problems is the capital budgeting/project selection problem where the only
integers allowed for values of the decision variable are "0" and "1". Again, a decision variable value of
"0" means we do not accept or fund that decision variable, "1" means we do accept (or fund or include)
that decision variable in our capital budget or project selection portfolio. The 0/1 variable is also
referred to as a binary variable.

By constraining the decision variables to 0 and 1, the integer linear programming model can handle
almost any kind of project interdependency. To illustrate, let us see how the following kinds of projects

interdependencies are incorporated in the integer linear programming model:

Mutual Exclusiveness

If two or more projects are mutually exclusive, acceptance of any one project out of the set of mutually
exclusive projects, automatically precludes the acceptance of all other projects in the set.

Contingency

A contingency relationship between two or more projects implies that the acceptance of one project is
contingent on the acceptance of some other project (s).

Complementariness

If undertaking a project influences favorably the cash flows of another project, the two projects are
complementary projects. To illustrate how complementarity is reflected in the integer linear
programming model, consider two projects Rand S. Either of them can be accepted individually.
However, if both are accepted together the following benefits will accrue:
(i) The cost will reduce by 5 percent. (ii) The net cash inflow will increase by 10 percent.

6. A mathematical programming model is formulated in terms of two broad categories of equations: (i)
the objective function, and (ii) the constraint equations. The objective function represents the goal or
objective the decision maker seeks to achieve.

Constraint equations represent restrictions-arising out of limitations of resources, environmental