Definition: Mutually exclusive is a situation where two or more scenarios can’t happen simultaneously. If one scenario occurs it is not possible for the others to take place.
What Does Mutually Exclusive Mean?
In statistics, mutually exclusive scenarios are identified as events that can’t happen at the same time. The probability for event Y to happen if event X occurs will always be zero. For example, if a coin is flipped, the two possible results of this action are mutually exclusive, since the appearance of one side will instantly eliminate the possibility for the other side to appear. From a business standpoint, mutually exclusive scenarios are evaluated in capital budgeting situations.
A capital budget is the evaluation of multiple investment opportunities with the goal of picking the most profitable and value-maximizing options. It is possible to evaluate independent projects or mutually exclusive projects. Independent projects are those with no effect on the cash flow of other projects being analyzed. These options should be accepted if their net present value is equal or higher than zero.
In the case of mutually exclusive projects, those with cash flows that affect other potential projects, since only one of them can be picked; the one with the highest net present value must be selected.
Example
A company that manufactures wallets for men is currently evaluating all its investment opportunities for the coming year. The company has three options to invest its resources. The first option is to increase its plant installed capacity, to meet an increasing demand.
The second project is a training center for young people, to teach them skills to work for the company in the future; and the third one is a project to renew all the staff’s computer equipments. Since the plant’s expansion is top-priority it was considered an independent project that will be approved as long as the net present value is higher than zero. As for the two other projects, they are mutually exclusive since the company’s resources can only fund one of them.
After the financial calculations were made the new computers were approved, since they provided a higher net present value ($120,000) that comes from an increase in the staff’s overall productivity. As these projects were mutually exclusive, the training center was discarded and will be submitted for review again next year.
