1 I. Mutually Exclusive Investment Projects with Different Lives
The traditional NPV technique may not be the appropriate criterion to select a project from mutually exclusive investment projects, if these projects have different lives. The underlying reason is that, compared with a long-life project, a short-life project can be replicated more quickly in the long run. In order to compare projects with different lives, we compute the NPV of an infinite replication of the investment project. For example, let Projects A and B be two mutually exclusive investment projects with the following cash flows.
Year |
Project A |
Project B |
|---|---|---|
0 |
100 |
100 |
1 |
70 |
50 |
2 |
70 |
50 |
3 |
50 |
By assuming a discount rate of 12 percent, the traditional NPV of Project A is 18.30 and the NPV of Project B is 20.09. This shows that Project B is a better choice than Project A. However, the NPV with infinite replications for Project A and B should be adjusted into a comparable basis.
In order to compare Projects A and B, we compute...
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© 2006 Springer Science+Business Media, Inc.
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Lee, CF., Lee, A.C. (2006). Capital budgeting decisions with different lives. In: Lee, CF., Lee, A.C. (eds) Encyclopedia of Finance. Springer, Boston, MA. https://doi.org/10.1007/978-0-387-26336-6_80
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DOI: https://doi.org/10.1007/978-0-387-26336-6_80
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