What are the different methods used to handle the problem of unequal project lives in capital budgeting?

In capital budgeting, the problem of unequal project lives refers to situations where the cash flows generated by different investment projects occur over different time periods. This discrepancy in project durations can make it challenging to compare and evaluate the projects accurately. However, there are several methods that can be used to handle this problem of unequal project lives in capital budgeting. These methods include:

1. Equivalent Annual Cost (EAC) Method: The EAC method involves converting the cash flows of each project into an equivalent annual cost. This is done by calculating the present value of each project's cash flows and then dividing it by the annuity factor. By converting the cash flows into an equivalent annual cost, it becomes easier to compare projects with different durations.

2. Equivalent Annual Benefit (EAB) Method: Similar to the EAC method, the EAB method converts the cash flows of each project into an equivalent annual benefit. This is done by calculating the present value of each project's cash flows and then dividing it by the annuity factor. The EAB method allows for a comparison of projects with different durations based on their equivalent annual benefits.

3. Replacement Chain Method: The replacement chain method involves breaking down the longer-lived project into multiple shorter-lived projects. This is done by dividing the longer project into segments that match the duration of the shorter-lived project. By doing so, the cash flows of the longer project can be compared directly with the cash flows of the shorter project.

4. Common Life Approach: The common life approach involves assuming a common duration for all projects under consideration. This approach requires estimating the duration that is reasonable for all projects and then adjusting the cash flows of each project to match this common duration. By assuming a common life, the projects can be compared on an equal basis.

5. Modified Internal Rate of Return (MIRR): The MIRR method adjusts the cash flows of each project to a common duration by reinvesting the cash flows at a predetermined rate. This rate is typically the cost of capital or the required rate of return. By adjusting the cash flows to a common duration, the MIRR method allows for a fair comparison of projects with different durations.

It is important to note that each method has its own advantages and limitations. The choice of method depends on the specific circumstances and requirements of the capital budgeting decision.