Equivalent Annual Cost
Equivalent Annual Cost (EAC) is the cost per year of owning an asset over its entire lifespan.
It is often used as a decision making tool when comparing objects of unequal lifespans.
EAC is calculated by multiplying an annuity factor with the NPV of a project. The EAC method implies that the project will be replaced by an identical project.
EAC=NPV*<math>A_{t,r}</math>
A practical example
A manager must decide on which machine to purchase:
Machine A
Investment cost 50000$
Expected lifetime 3 years
Annual maintainance 13000$
Machine B
Investment cost 150000$
Expected lifetime 8 years
Annual maintainance 7500$
The cost of capital is 5%.
The EAC for machine A is: (50000$*<math>A_{3,5}</math>)+13000$=31360$
The EAC for machine B is: (150000$*<math>A_{8,5}</math>)+7500$=30780$
Where A is the annuity factor for t years and 5% cost of capital.
The conclusion is to invest in machine B since it has a lower EAC.
Alternative method:
The manager calculates the NPV of the machines:
Machine A EAC=85400$*<math>A_{3,5}</math>=31360$
Machine B EAC=19847$*<math>A_{8,5}</math>=30780$
The result is the same, although the first method is easier it is essential that the annual maintainance cost is the same each year.
Alternatively the manager can use the NPV method under the assumption that the machines will be replaced for the same investment fee. The time horizon used in the NPV comparison must be set to 24 years (3*8=24) thus it becomes a slightly more complicated operation to perform than calculating the EAC.
See also
| List of Marketing Topics | List of Management Topics |
| List of Economics Topics | List of Accounting Topics |
| List of Finance Topics | List of Economists |