Question

When appraising mutually exclusive investments in plant and equipment, financial managers calculate the investments’ equivalent annual costs and rank the investments on this basis. Why is this necessary? Why not just compare the investments’ NPVs? Explain.

Answer 1

The comparison of annual costs is important because a comparison of NPVs when the lives of the projects are different or if projects are an ongoing basis, then an NPV comparison won't make sense.

Sometimes a machine costing $100,000 with 5 years life may not be more expensive than a machine $75,000 with a 3 years life.
It is better to compare the equivalent annual costs to ensure an objective evaluation.