How to Calculate Equivalent Annual Cost (EAC)

A straightforward breakdown of the formula for EAC and how to use it

Last Updated: May 24, 2022

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:

${\text{Asset Price}}*{\frac {\text{Discount Rate}}{1-(1+{\text{Discount Rate}})^{\text{-Periods}}}}+{\text{Annual Maintenance Costs}}$ .

Let's see how this equation is applied.

Steps

1
Determine the price of the asset.^{[1]
X
Research source} For example, suppose you are comparing two analyzers, A and B, costing $100,000 and $130,000, respectively. These are the Asset Prices.
2
Determine the expected lifespan for each.^{[2]
X
Research source} Suppose Analyzer A is expected to last 5 years, while Analyzer B is expected to last 7 years. These are the number of Periods.

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3
Determine your discount rate.^{[3]
X
Research source} 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.^{[4]
  X
  Research source} Suppose Analyzer A has an annual maintenance expense of $11,000, while Analyzer B has annual maintenance expense of $8,000.
4
Plug the numbers into the equation Asset Price x Discount rate / (1-(1+Discount Rate)^-Periods) + Annual Maintenance Costs.^{[5]
X
Research source} It should be apparent that Analyzer B is the more cost effective option, with a net savings of $2,677.03 a year, compared to Analyzer A.
- For Analyzer A, ${\text{EAC}}=\$100,000*{\frac {0.10}{(1-(1+0.10)^{-5})}}+\$11,000=\$37,379.75$
- For Analyzer B, ${\text{EAC}}=\$130,000*{\frac {0.10}{(1-(1+0.10)^{-7})}}+\$8,000=\$34,702.72$

Community Q&A

Question

A precision lathe costs $10,000 and will cost $20,000 a year to operate and maintain. If the discount rate is 10% and the lathe will last for 5 years, what is the equivalent annual cost of the tool?

Community Answer

Using the formula above: EAC = $10,000 * (10% / (1 - (1 + 10%)^-5) + $20,000 = $22,637.97