An Examination of Capital Budgeting Decision Alternatives For Mutually Exclusive Investments With Unequal Lives

The capital budgeting techniques for analyzing mutually exclusive alternatives all assume that the market imperfections that permit positive net present values at the initial purchase point continue to exist in subsequent periods. Many authors recommend that such investments be analyzed by computing the annualized net present value (ANPV). The appropriate investment choice would be the project with the largest ANPV. This method ignores the fact that the market may have a learning curve with respect to undervalued projects, and it can yield incorrect solutions if the equal risk assumption is relaxed. The perpetual replacement chain technique, which is used more for ongoing activities, assumes that the cost of the investment, the cash flows, and the required rate of return remain constant throughout the study period. These and other techniques can produce conflicting results depending on their underlying assumptions.