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Equivalent annual cost

In finance the equivalent annual cost (EAC) is the cost per year of owning and operating an asset over its entire lifespan.

EAC is often used as a decision making tool in capital budgeting when comparing investment projects of unequal lifespans. For example if project A has an expected lifetime of 7 years, and project B has an expected lifetime of 11 years it would be improper to simply compare the net present values (NPVs) of the two projects, unless neither project could be repeated.

The use of the EAC method implies that the project will be replaced by an identical project.

A practical example:
A manager must decide on which machine to purchase:

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    Fill the yellow fields to see the result in the green fields!
      A
    B
    C
    D
    1   Machine A  Machine B   
    2 Investment cost      dollars 
    3 Expected lifetime      years 
    4 Annual maintenance      dollars 
    5        
    6 The cost of capital is     
    7        
    8 EAC      dollars 
    9        
    10 The conclusion is to invest in the machine which has the lower EAC 
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    (source: Equivalent annual cost. (2006, October 1). In Wikipedia, The Free Encyclopedia. Retrieved 18:49, November 28, 2006, from http://en.wikipedia.org/w/index.php?title=Equivalent_annual_cost&oldid=78862331)

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