Deciding whether or not to invest in a future project based on the outcome of one or more current projects
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Project sequencing refers to the evaluation and selection of capital projects wherein the finance manager decides whether or not to invest in a future project based on the outcome of one or more current projects. It may also simply refer to the necessity of completing a number of projects in a certain order.
Capital Budgeting Process
Some projects are implemented in a certain order or sequence, so investing in a project creates an option to invest in future projects. For example, if a certain project generates profit, then it establishes the option to invest in another project in the future. On the other hand, the company can decide not to invest in the next project if the current one is not profitable.
Capital budgeting is one of the essential parts of any company and is one key responsibility of a finance manager. The process can involve purchasing costly assets that will be used for a long time, as well as identifying and evaluating capital projects, or determining how cash flows will unfold where cash flows are received over long periods.
Capital budgeting is also involved in replacing old assets, moving offices to a new location, and expanding operations to a different area. It’s essential to make the right decisions in the capital budgeting process, as this plays a key role in the success of the company. It will also help to maximize shareholder value, which is what any business wants to achieve.
Importance of Project Evaluation and Sequencing
The connection between different projects can make the analysis of cash flow to make capital decisions challenging. It is up to the finance manager to look at various issues when evaluating and selecting projects. While all capital projects are analyzed thoroughly, different categories can affect the evaluation and selection of capital projects.
One of the categories is project sequencing. In some cases, projects can only be implemented in a sequence. Once the first project is executed and is found to be profitable, that then creates the option to execute the second project. In other words, the second project will be implemented only after the execution of the first one, which should be profitable before moving on to the next project.
Independent or Mutually Exclusive Projects
If the capital projects being analyzed by a company do not fall under the project sequencing category, then they can be independent or mutually exclusive projects. When two projects are independent, the cash flows and profitability are also independent of each other. However, if two projects are mutually exclusive, a company will aim to implement only one of the two projects.
Another situation is where a company enjoys unlimited resources and can execute all profitable projects simultaneously. But if there are more projects than available resources, then the company needs to use capital rationing. This means that they will implement projects with the highest impact on value for shareholders.
Project sequencing plays an important role in the entire capital budgeting process, as a single project can easily have a huge impact on other projects. That is why it is essential for finance managers to gain a thorough understanding of all the principles, categories, and steps involved in the budgeting process.
Thank you for reading CFI’s guide to project sequencing. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following CFI resources will be helpful:
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