In capital budgeting, choosing between mutually exclusive projects involves selecting one project from a set of projects.

This decision is important because it impacts the company's future plans and financial stability.

For example, consider an automobile manufacturing company with the option to invest in either Project A or Project B, but not both.

Project A requires a one hundred thousand dollar investment and is expected to generate twenty thousand dollars annually for seven years.

Project B requires the same investment but will generate thirty thousand dollars annually for five years.

The company might use the Net Present Value or NPV method, which helps determine the profitability of each project by discounting future cash flows to their present values.

The discount rate is considered eight percent per annum. Calculating the NPV for both projects reveals that Project A has an NPV of four thousand dollars, while Project B has an NPV of twenty thousand dollars approximately.

Since Project B has a higher NPV, it is a more financially beneficial choice and would be accepted, rejecting Project A.

This method ensures the company maximizes firm value and aligns its investments with its financial goals.