GFM13 - Annual equivalent cost in project evaluation.

Mastering Capital Budgeting: Comparing Projects with Different Lifespans

In this video, we explore the challenge of evaluating competing capital budgeting projects with different investment lives. We discuss why the simple net present value (NPV) criteria can be problematic and introduce the concept of annual equivalent cost (AEC) as a solution. By calculating the annuity factor for machines with different lifespans, we can compare their costs on an annual equivalent basis, ensuring a fair and accurate evaluation of which machine will enhance our firm's value the most.

00:00 Introduction to Capital Budgeting Challenges
00:24 Evaluating Machines with Different Lifespans
01:29 Common Time Horizon Approach
02:12 Annual Equivalent Cost Method
02:45 Calculating Annuity Factors
03:45 Comparing Annual Equivalent Costs
04:45 Conclusion: Making the Best Decision