Equivalent Annual Annuity
AdvancedEquivalent annual annuity (EAA) is a method of comparing projects with different lifespans by converting each project's net present value into an equal annual amount over its life.
Comparing net present values directly can be misleading when projects last for different lengths of time. A longer project may show a higher net present value simply because it runs longer. EAA puts projects on an annual basis.
To calculate EAA, a project's net present value is divided by an annuity factor based on the discount rate and the project's life. For example, at a 10% discount rate, Project A has a net present value of 5,000 over 3 years, giving an EAA of about 2,011. Project B has a net present value of 7,000 over 5 years, giving an EAA of about 1,847. If each project could be repeated, A creates more value per year.
EAA assumes projects can be replaced with similar ones at the end of their lives, which may not be realistic.
A related idea, equivalent annual cost, is used when comparing assets that perform the same function but have different costs and lifespans, such as two machines, by converting total costs into an annual amount.
For worked examples and full lessons, visit notesbysara.org.