The equivalent annual annuity approach - Evaluating projects with unequal lives

Evaluating projects with unequal lives

Blanche Inc. is Canadian firm that wants to expand its business internationally. It is considering potential projects in both Spain and the United States, and the Spanish project is expected to take six years, whereas the U.S. project is expected to take only three years. However, the firm plans to repeat the U.S. project after three years. These projects are mutually exclusive, so Blanche Inc.'s CFO plans to use the equivalent annual annuity (EAA) approach to analyze both projects. The expected cash flows for both projects follow:

Spanish Project Cash Flow

Project:	Cash Flow
Year 0	-$700,000
Year 1	$240,000
Year 2	$270,000
Year 3	$290,000
Year 4	$250,000
Year 5	$130,000
Year 6	$110,000

U.S. Project Cash Flow

Project:	Cash Flow
Year 0	-$520,000
Year 1	$275,000
Year 2	$280,000
Year 3	$295,000

If Blanche Inc.'s cost of capital is 13%, what is the NPV of the Spanish project?

$161,238

$171,315

$191,470

$201,547

If Blanche Inc.'s cost of capital is 13%, what is the NPV of the U.S. project?

$147,093.70

$66,739.95

$71,128.66

$67,938.77

What is the EAA for the U.S. project?

$23,937.05

$28,439.52

$14,722.73

$62,297.41

What is the EAA for the Spanish project?

$39,977.75

$66,070.93

$50,417.63

$55,610.58

If the CFO uses the EAA approach to decide which project to undertake, he should choose the project because it has the EAA.