What are mutually exclusive investments?

Banking & FinanceFinance ManagementGrowth & Empowerment

Mutually exclusive investments are investments that are connected to each other where taking up one negates the use of the other investment. These investments usually serve different purposes but when one of them is undertaken, the other cannot be done. There are many examples of mutually exclusive investments, but they are primarily related to funds invested to complete different projects.

Note − Mutually exclusive investments are usually for different projects. However, they may be contingent investments that are derived when an extra investment is needed to serve the major purpose.

Characteristics of Mutually Exclusive Investments

Here are the major characteristics of mutually exclusive investments −

  • Mutually Exclusive − As the name suggests, mutually exclusive investments are exclusive to one another. When one investment is done, the other cannot be undertaken. For example, when a less capital-intensive budget is undertaken instead of a high capital-intensive project, the investment is mutually exclusive. The less capital-intensive project will cancel the high capital intensive one in this case.

  • Different needs − Mutually exclusive investments are often made for different needs. If there are investments for the same need, one investment will cancel the other. In the above example, the outcome of a less intensive budget will cancel the results of the highly intensive one, and hence they are separate from one another.

  • Preferred needs to be selected − In the case of mutually exclusive investments, the preferred or the more suitable one is usually undertaken by the firms. The investment that has a high growth probability will be chosen. This is also the principle behind the long-term profitability of a company. If the managers of a company think that there are two mutually exclusive investments, they must select one that is more profitable or the one which offers more benefits in the future.

  • Alternative investments − The firms often sort the different investment needs when they seek more returns on their investments. Therefore, different investments are kept in the pipeline so that in the case of failure in one can be compensated or replaced by another investment. This is however not applicable to investments where large funds are involved, such as capital budgeting decisions.

  • Minimum two options − : To have mutually exclusive investments, there must be at least two decisions to consider. The number of investments can be anything upwards, but a minimum of two investment decisions must be there to select one of the mutually exclusive investment decisions.

  • Long-term Vs Short-term investments − It is important to find out the mutually exclusive investments to get a long-term benefit from them. While there can be many short-term mutually exclusive investments decisions, the long-term decisions are more important for a firm that takes a critical view on investments in terms of growth and profitability of the firm.

raja
Published on 27-Oct-2021 05:33:37

Advertisements