What It Is, How It Works, Examples

What Is the Equivalent Annual Worth (EAC)?

Equivalent annual price (EAC) is the once a year price of proudly proudly owning, operating, and maintaining an asset over its whole life. Companies continuously use EAC for capital budgeting picks, as it we could in a company to test the cost-effectiveness of moderately a large number of belongings with unequal lifespans.

Understanding the Equivalent Annual Worth (EAC)

Equivalent annual price (EAC) is used for moderately a couple of purposes, along side capital budgeting. Alternatively it is used most continuously to research two or further conceivable duties with different lifespans, where costs are one of the comparable variable.

Other uses of EAC include calculating the optimal life of an asset, understanding if leasing or purchasing an asset is the better chance, understanding the magnitude of which maintenance costs will impact an asset, understanding the crucial price monetary financial savings to fortify purchasing a brand spanking new asset, and understanding the cost of holding present equipment.

The EAC calculation elements in a discount value or the cost of capital. Worth of capital is the desired return crucial to make a capital budgeting undertaking—similar to development a brand spanking new production facility—successful. Worth of capital accommodates the cost of debt and the cost of equity and is used by corporations internally to judge whether or not or now not a capital undertaking is undoubtedly definitely worth the expenditure of assets.

The Components for the Equivalent Annual Worth


$\begin{array}{cc}& \text{EAC}=\frac{\text{Asset Price}\times \text{Cut price Price}}{1-(1+\text{Cut price Price}{)}^{-n}}\\ & \text{where:}\\ & \text{Cut price Price}=\text{Return required to make undertaking}\\ & \text{successful}\\ & n=\text{Amount of classes}\end{array}$

get started{aligned} &text{EAC} = frac{ text{Asset Price} events text{Cut price Price} }{ 1 – ( 1 + text{Cut price Price})^{-n} } &textbf{where:} &text{Cut price Price} = text{Return required to make undertaking} &text{successful} &n = text{Number of classes} end{aligned} ​EAC=1−(1+Cut price Price)−nAsset Price×Cut price Price​where:Cut price Price=Return required to make undertakingsuccessfuln=Amount of classes​

How you can Calculate the Equivalent Annual Worth

1. Take the asset price or price and multiply it throughout the discount value.
2. The discount value is ceaselessly referred to as the cost of capital, which is the desired return crucial to make a capital budgeting undertaking, similar to development a brand spanking new production facility, successful.
3. Throughout the denominator add 1 + the discount value and raise the result as an exponent to the number of years for the undertaking. Subtract the result via 1 and divide the numerator decide throughout the denominator.
4. Many financial online calculators are available to calculate EAC.

Example of the Equivalent Annual Worth

As discussed earlier, EAC we could in managers to test NPVs of more than a few duties over different classes, to accurately make a decision the most suitable option. Consider two variety investments in apparatus equipment:

1. Software A has the following:

• An initial capital outlay of $105,000
• An expected lifespan of three years
• An annual maintenance expense of $11,000

2. Software B has the following:

• An initial capital outlay of $175,000
• An expected lifespan of five years
• An annual maintenance expense of $8,500

The cost of capital for the company making the decision is thus 5%.

Next, we calculate the EAC, which is equal to the net supply value (NPV) divided throughout the prevailing value annuity factor or A(t,r), while making an allowance for the cost of capital or r, and the number of years in question or t.

The annuity factor is calculated as follows:


$\begin{array}{cc}& \text{Annuity Factor}=\frac{1-\frac{1}{(1+r{)}^t}}{r}\\ & \text{where:}\\ & r=\text{Worth of capital}\\ & t=\text{Amount of classes}\end{array}$

get started{aligned} &text{Annuity Factor} = frac{ 1 – frac{ 1 }{ ( 1 + r ) ^ t} }{ r } &textbf{where:} &r = text{Worth of capital} &t = text{Number of classes} end{aligned} ​Annuity Factor=r1−(1+r)t1​​where:r=Worth of capitalt=Amount of classes​

The use of the system above, the annuity factor or A(t,r) of each and every undertaking must be calculated. The ones calculations may well be as follows:


$\begin{array}{cc}& \text{Software A, A(t, r)}=\frac{1-\frac{1}{(1+.05{)}^3}}{.05}=2.72\end{array}$

get started{aligned} &text{Software A, A(t, r)} = frac{ 1 – frac{ 1 }{ ( 1 + .05) ^ 3 } }{ .05 } = 2.72 end{aligned} ​Software A, A(t, r)=.051−(1+.05)31​​=2.72​


$\begin{array}{cc}& \text{Software B, A(t, r)}=\frac{1-\frac{1}{(1+.05{)}^5}}{.05}=4.33\end{array}$

get started{aligned} &text{Software B, A(t, r)} = frac{ 1 – frac{ 1 }{ ( 1 + .05) ^ 5 } }{ .05 } = 4.33 end{aligned} ​Software B, A(t, r)=.051−(1+.05)51​​=4.33​

Next, the initial costs must be divided throughout the annuity factor or A(t,r) while together with in the once a year maintenance price. The calculation for EAC is:


$\begin{array}{cc}& \text{EAC Software A}=\frac{\$105,000}{2.72}+\$11,000=\$49,557\end{array}$

get started{aligned} &text{EAC Software A} = frac{ $105,000 }{ 2.72 } + $11,000 = $49,557 end{aligned} ​EAC Software A=2.72$105,000​+$11,000=$49,557​


$\begin{array}{cc}& \text{EAC Software B}=\frac{\$175,000}{4.33}+\$8,500=\$48,921\end{array}$

get started{aligned} &text{EAC Software B} = frac{ $175,000 }{ 4.33 } + $8,500 = $48,921 end{aligned} ​EAC Software B=4.33$175,000​+$8,500=$48,921​

By means of standardizing the once a year price, a manager in charge of a capital budgeting solution where price is the only issue would make a selection Software B because it has an EAC that is $636 lower than Software A.

The Difference Between the Equivalent Annual Worth and the Entire-life Worth

Entire-life price is the overall expense of proudly proudly owning an asset over its whole life, from gain to disposal, as made up our minds via financial analysis. It is also known as a “life-cycle” price, which comprises gain and arrange, design and development costs, operating costs, maintenance, comparable financing costs, depreciation, and disposal costs.

Entire-life price moreover takes into consideration certain costs which can be most often lost sight of, similar to those related to environmental and social impact elements.

The an an identical annual price (EAC) is the once a year price of proudly proudly owning, operating, and maintaining an asset over its whole life while all the life price is the overall price of the asset over its whole life.

Hindrances of The use of the Equivalent Annual Worth

A limitation with EAC, as with many capital budgeting picks, is that the discount value or price of capital must be estimated for each and every undertaking. Unfortunately, the forecast can turn into erroneous, or variables can trade over the life of the undertaking or life of the asset this is be thought to be.