**REPLACEMENT CHAIN METHOD:**

**Application:** The Replacement Chain Method is used to compare two mutually
exclusive capital proposals of unequal lives.
The result of applying the model to the projects is an NPV for each
project for one or more iterations (the "links" of the chain) of each
project. The model can be applied to
more than two mutually exclusive projects, but the set-up becomes cumbersome
and the Equivalent Annual Annuity method may be more appropriate.

**Methodology:**

1) Determine the number of years of cash flow (the "project lives") for each project by finding the lowest common denominator (LCD) of all the "project lives". This LCD is the number of years for which each projects cash flows must be recalculated.

2) For each project assume that during the last year of each iteration a
reinvestment (equal to the original investment) must be made in order to
generate positive cash flows for the following iteration. This is true for every iteration of the
project *except for the very last* *year* when all projects reach a common
terminal finish time. In the very last
year there is no reinvestment for future cash flows, so the value of the cash
flows of the very last year equals the cash flow of the last year of the
original project.

3) Once the revised cash flows have been determined, generate the discount
factors for those years. Calculate the present value for each cash flow.
Calculate the Net Present Value for the project. Compare projects; choose
that project with largest NPV.