Question

You are trying to determine which of two mutually exclusive projects to undertake. Project Adam has an initial outlay of $10,000, an NPV of $4,392.15, an IRR of 11.33%, and an EAA of $1,158.64. Project Eve has an initial outlay of $15,000, 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%, and the projects have different lives. If the projects are repeatable, then: You should do both projects because they 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 Project Adam because it has a higher IRR. You should do neither projects since neither of them adds value to you.

Answer 1

You Should do Project Adam because it has higher EAA.

If two projects are mutually exclusive which means only one project can be selected and both have different life then Equivalent Annual Annuity (EAA) Approach can provide base for decision making. A project with higher EAA should be selected as it provide higher equivalent annual cash flow to the company.

NPV and IRR can be ignored in case of analysis of projects with different life.

Hope this will help, please do comment if you need any further explanation. Your feedback would be highly appreciated.