What happens in the case of two mutually exclusive projects with different cash flow lifespans?

When dealing with two mutually exclusive projects that have different cash flow lifespans, the best approach to compare them is to use the Equivalent Annual Annuity (EAA) method. This method allows for the comparison of projects by converting their net present values (NPVs) into an annualized format, making it easier to evaluate projects with varying durations.

The EAA takes into account the time value of money and the different cash flow timelines. By converting the NPV of each project into a common annual figure, it provides a clear basis for comparison. This is particularly important for mutually exclusive projects because selecting one automatically excludes the other, so decision-makers need to ensure they select the project that maximizes value over its lifespan.

Using NPV alone wouldn't give a fair comparison due to the differing time periods; it simply shows the total value added by each project without accounting for how long those cash flows are generated. The internal rate of return (IRR) can also be misleading for projects of unequal lifespans as it does not account for project size or cash flow timing adequately.

Thus, utilizing EAA allows a more accurate and intuitive comparison of the two mutually exclusive projects, facilitating a well-informed decision.