Equivalent Annual Cost (EAC)

Equivalent Annual Cost (EAC) converts the total cost of owning and operating an asset over its life into an equal annual amount. It is commonly used in capital budgeting to compare alternatives with different lifespans on a consistent, annual basis.

Key takeaways

• EAC standardizes lifetime costs as an annual figure, making comparisons between assets with different lives straightforward.
• It is useful for choosing between purchase versus lease, determining optimal replacement timing, and assessing maintenance impacts.
• Accuracy depends on the discount rate and assumptions about future operating and maintenance costs.

When to use EAC

• Comparing projects or equipment with unequal useful lives.
• Deciding whether to replace or retain existing assets.
• Evaluating lease vs. buy decisions.
• Assessing the impact of maintenance and operating costs across alternatives.

Formula and concept

Calculate the annualized capital cost using the capital recovery (annuity) factor, then add any recurring annual operating/maintenance costs.

Capital recovery factor (CRF):
CRF = r / (1 − (1 + r)^−n)

EAC:
EAC = Asset purchase price × CRF + Annual operating/maintenance cost (and any other recurring annual costs)

where:
* r = discount rate (cost of capital)
* n = number of periods (years) of the asset’s life

Equivalently, you can compute the annuity factor A(n,r) = (1 − (1 + r)^−n) / r and convert a present value into an annual amount by dividing the PV by A(n,r).

Step-by-step calculation

1. Determine the asset’s initial cost (PV), expected life (n), and the discount rate (r).
2. Compute the annuity/annuity factor: A(n, r) = (1 − (1 + r)^−n) / r.
3. Annualize the purchase cost: Annualized purchase = PV / A(n, r).
4. Add recurring annual operating or maintenance costs.
5. Compare EAC values across alternatives — choose the lowest EAC if cost is the primary criterion.

Example: Comparing two machines

A company considers two machines with a 5% cost of capital.

Machine A
* Purchase price: $105,000
Life: 3 years
Annual maintenance: $11,000

Machine B
* Purchase price: $175,000
Life: 5 years
Annual maintenance: $8,500

Compute annuity factors:
* A(3, 0.05) = (1 − (1.05)^−3) / 0.05 ≈ 2.723
* A(5, 0.05) = (1 − (1.05)^−5) / 0.05 ≈ 4.329

Compute EAC:
* EAC_A = 105,000 / 2.723 + 11,000 ≈ $49,563 per year
* EAC_B = 175,000 / 4.329 + 8,500 ≈ $48,921 per year

Result: Machine B has the lower EAC (about $642 less per year) and is the cost-preferred option if cost alone governs the decision.

EAC vs. whole-life cost

• Whole-life cost (life-cycle cost) is the total expense over an asset’s entire life, including purchase, installation, operating costs, maintenance, financing, depreciation, disposal, and sometimes external impacts.
• EAC converts whole-life costs into an equivalent annual figure for easier comparison across alternatives. Both perspectives are complementary: whole-life cost shows total expenditure, while EAC supports annualized comparisons.

Limitations and caveats

• EAC depends on the chosen discount rate; incorrect or changing rates can alter conclusions.
• It typically assumes constant annual operating costs and consistent replacement patterns, which may not hold in practice.
• Salvage/residual values, taxes, inflation, and timing of maintenance can affect results and should be included where material.
• EAC focuses on cost; non-cost factors (quality, capacity, risks, strategic fit) should also influence decisions.

Bottom line

EAC is a practical tool for comparing the annualized cost of alternatives with different lifespans. When used with careful assumptions about the discount rate, operating costs, and other relevant cash flows, it helps managers make consistent, cost-effective capital budgeting choices.