523 Equivalent Annual Cost



How to Calculate Equivalent Annual Cost (EAC)

Equivalent annual cost (EAC) is the cost per year for owning or maintaining an asset over its lifetime. Calculating EAC is useful in budgeting decision-making by converting the price of an asset to an equivalent annual amount. EAC helps to compare the cost effectiveness of two or more assets with different lifespans. The formula for EAC is:
Asset Price∗Discount Rate1−(1+Discount Rate)-Periods+Annual Maintenance Costs{\displaystyle {\text{Asset Price}}*{\frac {\text{Discount Rate}}{1-(1+{\text{Discount Rate}})^{\text{-Periods}}}}+{\text{Annual Maintenance Costs}}}.
Let's see how this equation is applied.

Steps

  1. Determine the price of the asset.For example, suppose you are comparing two analyzers, A and B, costing 0,000 and 0,000, respectively. These are the Asset Prices.
  2. Determine the expected lifespan for each.Suppose Analyzer A is expected to last 5 years, while Analyzer B is expected to last 7 years. These are the number of Periods.
  3. Determine your discount rate.Discount rate is the cost of capital, or how much return your capital is required to generate each year. Say your organization uses a Discount Rate of 10%.
    • Determine the annual maintenance costs for the asset. Suppose Analyzer A has an annual maintenance expense of ,000, while Analyzer B has annual maintenance expense of ,000.
  4. Plug the numbers into the equation Asset Price x Discount rate / (1-(1+Discount Rate)^-Periods) + Annual Maintenance Costs.It should be apparent that Analyzer B is the more cost effective option, with a net savings of ,677.03 a year, compared to Analyzer A.
    • For Analyzer A,Discount Rate1−(1+Discount Rate)-Periods{\displaystyle {\frac {\text{Discount Rate}}{1-(1+{\text{Discount Rate}})^{\text{-Periods}}}}}is the inverse of the annuity factor (AF).AF=1−(1+Discount Rate)-PeriodsDiscount Rate{\displaystyle {\text{AF}}={\frac {1-(1+{\text{Discount Rate}})^{\text{-Periods}}}{\text{Discount Rate}}}}, is used to calculate present values of annuities.
      • It is often abbreviated asAF(n,r){\displaystyle AF(n,r)}, which can be readily computed by financial calculators plugging in values for n (periods) and r (discount rate). AF can also be looked up from an annuity factor table. The EAC formula may be simplified asAsset PriceAnnuity Factor+Annual Maintenance Cost{\displaystyle {\frac {\text{Asset Price}}{\text{Annuity Factor}}}+{\text{Annual Maintenance Cost}}}.
      • From an , AF(5,10%) = 3.7908 for Analyzer A and AF(7,10%) = 4.8684 for Analyzer B, so EAC = 0,000/3.7908 + ,000 = ,379.65 for Analyzer A and 0,000/4.8684 + ,000 = ,702.81 for Analyzer B.
      • Note that these figures are very close to the actual figures as calculated above. The minuscule differences arise from rounding errors attributed to AF having only 5 significant figures from the AF table.





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Watch How to Calculate Equivalent Annual Cost (EAC) video
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Date: 10.01.2019, 10:38 / Views: 54254