ACCA/CAT

The equivalent annual cost (EAC) approach

This approach computes the present value of costs for each project over a cycle and then expresses the present value in an annual equivalent cost using the appropriate annuity factors for each cycle. The annual equivalent of NPVs of the two or more projects can then be compared. Having calculated the EAC for each cycle and each project, then compare the EACs. The project that has the lowest EAC over the cycles is the better one if lowest outlay is the objective or the higher EAC would be preferred if the highest revenue were the objective.

Infinite re-investment approach

This approach is appropriate when projects of unequal lives and unequal risks are being considered. The first step to take will be to establish the net present value of the projects in the normal way and then calculate the net present value of projects to infinity using the formula:

NPV μ = NPV of project/PV of annuity for the life of project at discount rate

Discount rate for the project

The project, which has the highest NPV to infinity, is the one to recommend

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