Equivalent Annual Costs

A4.9  In some cases it can be helpful to calculate PVs in terms of Equivalent Annual Costs (EAC), rather than NPVs or NPCs. A cost of £100 in the middle of Year 0 is equivalent to a stream of 10 annual costs of £12.03 starting in the middle of Year 1 when using a 3.5% annual discount rate. It can be demonstrated that such a cost stream has a PV of £100 when discounting at 3.5% per annum. An asset that costs £100 and has an expected life of 10 years is thus said to have an EAC of £12.032. Table 3 below provides EAC factors for a 3.5% discount rate.

A4.10  EACs can be useful when contemplating replacement of a capital asset, where there is a need to compare alternative assets with different lives.

Example: Consider two options for replacing a boiler. In Option X a boiler with an expected life of 7 years may be purchased for £2,000. Under Option Y another boiler with an expected life of 10 years may be purchased for £2,500. Which should be purchased? 

The relevant costs may be annuitised using EACs as follows:

In this case, the initially more expensive boiler would be the more cost-effective choice.