An analyst will need to use the team approach to evaluate projects with unequal lives when the projects are:
Equivalent annual annuities
Another method to deal with the unequal life problem of projects is the equivalent annual annuity (EAA) method. In this method, the annual cash flows under the alternative investments are converted into a constant cash flow stream whose NPV is equivalent to the NPV of the comparative project’s initial stream.
Consider the case of Cute Camel Lumber Company:
Cute Camel Lumber Company is considering a three-year project that has a weighted average cost of capital of 12% and a net present value (NPV) of $49,876. Cute Camel Lumber Company can replicate this project indefinitely.
The equivalent pension approach is one of two methods used in capital budgeting to compare mutually exclusive projects to those with unequal lifetimes. The EAA approach calculates the constant annual cash flow that a project will generate over its lifetime if the project is an annuity.
Learn more about EAA here
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