Question

You are trying to determine which of two mutually exclusive projects to undertake. Both projects have the same initial outlay. Project Adam has an NPV of $4,392.15, an IRR of 11.33%, and an EAA of $1,158.64. Project Eve has an NPV of $5,833.73, an IRR of 9.88%, and an EAA of $1,093.50. The cost of capital for both projects is 9%, the projects have different lives, and the projects are not repeatable. What should you do?

• You should do Project Adam because it has a higher IRR.
• You should do both projects because both have positive NPVs.
• You should do Project Adam because it has a higher EAA.
• You should do Project Eve because it has a higher NPV.
• You should do neither project because neither of them would add value to your company.

Answer 1

As both the projects have unequal lifes and they cannot be repeated, we cannot use the NPV or IRR approach. The most appropriate method to use in capital budgeting for projects with unequal lives is the EAA method or the equivalent annual annuity method.

The EAA calculated the annuity for every project throughout it's lifespan to make the projects more comparable.

As Project Adam EAA > Project Eve EAA

You should do project Adam because it has a higher EAA

Do let me know in the comment section in case of any doubt.