- CFA Exams
- CFA Level I Exam
- Study Session 7. Corporate Finance (1)
- Reading 19. Capital Budgeting
- Subject 2. Comparing projects with unequal lives

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**CFA Practice Question**

Which of the following statements with respect to comparing two projects with unequal lives is false?

B. The equivalent annual annuity method calculates the annuity payment required each year in order to make the present value of the operating cash flows equal to the NPV of the project.

C. The replacement chain approach requires an assumption as to how much it would cost to replace the machine with the shorter life so that an estimate can be formed as to how much cash flows will be generated from both machines over a uniform period.

D. The replacement chain method involves the equalizing the lives of the two machines by extending the life of the shorter period machine so that it equals the life of the longer period machine.

A. The project with the lowest annuity (EAA) is considered to be the better investment.

B. The equivalent annual annuity method calculates the annuity payment required each year in order to make the present value of the operating cash flows equal to the NPV of the project.

C. The replacement chain approach requires an assumption as to how much it would cost to replace the machine with the shorter life so that an estimate can be formed as to how much cash flows will be generated from both machines over a uniform period.

D. The replacement chain method involves the equalizing the lives of the two machines by extending the life of the shorter period machine so that it equals the life of the longer period machine.

Correct Answer: A

Actually, the project with the highest equivalent annual annuity (EAA) is considered to be the better investment. This would imply that once the time difference between the projects are taken into account, the project with higher EAA is generating higher average annual cash flows.

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