Unformatted text preview: heir respective NPVs of $11,277.24 and $19,013.27.
Spreadsheet Use Comparison of the net present values of two projects with
unequal lives also can be calculated as shown on the following Excel spreadsheet. CHAPTER 10 Risk and Refinements in Capital Budgeting 443 Ignoring the differences in project lives, we can see that both projects are
acceptable (both NPVs are greater than zero) and that project Y is preferred
over project X. If the projects were independent and only one could be accepted,
project Y—with the larger NPV—would be preferred. On the other hand, if the
projects were mutually exclusive, their differing lives would have to be considered. Project Y provides 3 more years of service than project X.
The analysis in the above example is incomplete if the projects are mutually
exclusive (which will be our assumption throughout the remaining discussions).
To compare these unequal-lived, mutually exclusive projects correctly, we must
consider the differing lives in the analysis; an incorrect decision could result from
simply using NPV to select the better project. Although a number of approaches
are available for dealing with unequal lives, here we present the most efficient
technique—the annualized net present value (ANPV) approach. Annualized Net Present Value (ANPV) Approach
annualized net present value
An approach to evaluating
unequal-lived projects that
converts the net present value of
exclusive projects into an
equivalent annual amount (in
NPV terms). The annualized net present value (ANPV) approach converts the net present
value of unequal-lived projects into an equivalent annual amount (in NPV terms)
that can be used to select the best project.7 This net present value based approach
can be applied to unequal-lived, mutually exclusive projects by using the following steps:
Step 1 Calculate the net present value of each project j, NPVj, over its life, nj,
using the appropriate cost of capital, k.
7. The theory underlying this as well as other approaches for comparing projects with unequal lives assumes that
each project can be replaced in the future for the same initial investment and that each w...
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