Mutually exclusive projects refers to a set of projects, of which only a single one can be accepted for execution by a company or organization. Mutually exclusive projects are also assumed to be designed to fulfill the same task, and choosing one affects the cash availability for other projects.
The opposite of a mutually exclusive project is an independent project. An independent project does not affect the cash flow of other projects when chosen or rejected. In a scenario where capital budgeting criteria are used, all independent projects that meet these criteria should ideally be accepted and executed.
Companies that consider mutually exclusive or independent projects likely follow a capital budgeting decision-making process. This process helps decide the long-term investment decisions of a company and uses three financial metrics: the project's payback period, its net present value and its internal rate of return.
When a company chooses between mutually exclusive projects, the main criterion that is used is the project's net present value. A decision made using this capital budgeting rule theoretically leads to the correct decision being made every time. This rule also operates under the implicit assumption that all of the cash flow generated by the project can be reinvested to meet the company's capital costs.