In finance, the equivalent annual cost (EAC) is the cost per year of owning and operating an asset over its entire lifespan. It is calculated by dividing the negative NPV of a project by the "present value of annuity factor":
, where
where r is the annual interest rate and
t is the number of years.
Alternatively, EAC can be obtained by multiplying the NPV of the project by the "loan repayment factor".
EAC is often used as a decision-making tool in capital budgeting when comparing investment projects of unequal lifespans. However, the projects being compared must have equal risk: otherwise, EAC must not be used.[1]
The technique was first discussed in 1923 in engineering literature,[2] and, as a consequence, EAC appears to be a favoured technique employed by engineers, while accountants tend to prefer net present value (NPV) analysis.[3] Such preference has been described as being a matter of professional education, as opposed to an assessment of the actual merits of either method.[4] In the latter group, however, the Society of Management Accountants of Canada endorses EAC, having discussed it as early as 1959 in a published monograph[5] (which was a year before the first mention of NPV in accounting textbooks).[6]
^Copeland & Weston 1988, p. 51.
^Fish, John Charles Lounsbury (1923). Engineering Economics (2nd ed.). New York: McGraw-Hill. ASIN B001CZKN9K., and expanded upon in Grant, Eugene L. (1930). Principles of Engineering Economy. New York: Ronald Press.
^Jones & Smith 1982, p. 103.
^Jones & Smith 1982, p. 108.
^Edge, C. Geoffrey (1959). The appraisal of capital expenditures. Hamilton: Society of Industrial Accountants of Canada. OL 16634923M.
^Jones & Smith 1982, p. 106.
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