Capital Budgeting: Different Project Lives

CFA Level II Corporate Finance
#1

Hi everyone got a question here:

When considering 2 projects with different projects lives, must the project lives be accounted for in selecting the projects?

For eg if we have the following projects:

  • Project A: NPV $1000, N = 3
  • Project B: NPV $1500, N = 6

Just looking at the absolute NPV, Project B is $1500 which is greater than Project A’s $1000.

However if Project A is adjusted for the same N as Project B (N = 6) then Project A NPV = $2000 ($1000 x 2) which would be greater.

Which project should be selected based ont the above?

#2

Project A would be picked based on the equiv. annual annuity approach

NPV calculates present value so your logic wouldn’t make sense

#3

Equivalent Annual Annuity. Just plug your numbers into a TVM calculation with zero FV. Find for PMT. HIghest PMT = best PMT.

#4

Thanks for the inputs everyone

Does that mean that given 2 projects with different project lives, they cannot be selected soley by which has the higher NPV? Instead, the EAA has to be computed for both projects?

Also, are there any exceptions to this perhaps?

#5

No exceptions.

You cant compare NPV of projects having unequal lives

Use EAA and you will be fine

#6

Also should not compare projects with significantly different initial investment amounts.