Equivalent Annual Cost, Explained: How to Compare Equipment and Projects With Unequal Lives

You are choosing between two delivery vans. Van A costs $50,000 and will last about three years before maintenance eats you alive. Van B costs $75,000 and will run for six. Which one is actually cheaper?

If you answered "A, obviously — it costs $25,000 less," you have just fallen into the trap this article exists to fix. Sticker prices lie when lifespans differ. The $50,000 van replaced every three years can easily cost you more per year than the $75,000 van you buy once. Equivalent annual cost — EAC — is the calculation that puts both options on the same ruler so you can see which one really costs less.

Why Net Present Value Alone Cannot Answer This​

Most owners who have heard of capital budgeting reach for net present value (NPV): discount every future cash flow back to today at your cost of capital, add them up, and pick the project with the best number. NPV is the right tool for a go/no-go decision on a single project. It breaks down the moment you compare two options with different lifespans.

The problem is mechanical. A six-year van accumulates six years of discounted operating and maintenance costs; a three-year van accumulates only three. Comparing their NPVs directly is like comparing the total grocery bill of a family of six with a family of three and concluding the smaller family eats more efficiently. The totals cover different quantities of the same thing — years of service.

You need a per-year number. Equivalent annual cost converts each option's total lifetime cost, in present-value dollars, into a level yearly charge — the flat annual payment that is economically identical to the lumpy real cash flows. Once every option is expressed as dollars per year, the cheapest one wins, regardless of how long each lasts.

What Equivalent Annual Cost Actually Is​

Equivalent annual cost is the NPV of an asset's purchase, operating, and maintenance costs divided by the present-value annuity factor for its lifespan. In plain English: take everything the asset will ever cost you, collapse it into today's dollars, then spread it evenly across its life as if you paid the same amount every year.

Think of it as the asset's "true rent." If someone offered to provide you the van's three years of service for a flat annual fee, the EAC is the fee that would leave you exactly indifferent between renting and buying. A lower EAC means a cheaper asset, full stop — even when the sticker prices and lifespans point the other way.

One assumption sits underneath the whole method, and you should know it before you trust any EAC number: EAC assumes you will replace the asset with an identical one, at an identical cost, forever. A three-year van is really a chain of three-year vans stretching into the future; a six-year van is a chain of six-year vans. EAC compares the annual cost of one infinite chain against the other. That assumption is reasonable for workhorse equipment — vans, ovens, HVAC units — and shaky for technology that gets cheaper or obsolete fast. More on that below.

The Annuity-Factor Formula​

The formula has two steps. First, compute the present value of all costs:

PV of costs = purchase price + annual operating cost × annuity factor − salvage value discounted to today

Second, annualize it:

EAC = PV of costs ÷ annuity factor

The annuity factor (also called the present-value interest factor of an annuity) converts a stream of equal annual payments into a lump sum, or — used in reverse, as here — a lump sum into equal annual payments. For a discount rate r and a lifespan of n years:

Annuity factor = (1 − (1 + r)^−n) ÷ r

With a 10% discount rate and a 3-year life, the factor is 2.4869. With the same rate and a 6-year life, it is 4.3553. You do not need to memorize these: any spreadsheet computes the whole EAC in one cell with =PMT(rate, years, -PV_of_costs), which is exactly the annuity math in disguise.

The discount rate deserves a deliberate choice. It should be your cost of capital — what a dollar tied up in equipment costs you. A debt-free small business might use 8–12% as a hurdle rate; a business borrowing at 9% to buy the equipment should use at least 9%. Using 0% — simple averaging with no discounting — systematically favors long-lived assets, because it pretends a dollar spent in year six costs the same as a dollar spent today.

A Worked Example: The Two Vans​

Let us run the numbers on the vans from the opening, using a 10% discount rate and including annual maintenance.

Van A: $50,000 purchase, 3-year life, $13,000 per year in maintenance.

• Annuity factor (10%, 3 years) = 2.4869
• PV of maintenance = $13,000 × 2.4869 = $32,329
• PV of costs = $50,000 + $32,329 = $82,329
• EAC = $82,329 ÷ 2.4869 = $33,108 per year

Van B: $75,000 purchase, 6-year life, $10,000 per year in maintenance.

• Annuity factor (10%, 6 years) = 4.3553
• PV of maintenance = $10,000 × 4.3553 = $43,553
• PV of costs = $75,000 + $43,553 = $118,553
• EAC = $118,553 ÷ 4.3553 = $27,218 per year

Van B costs 50% more upfront and still wins by nearly $5,900 a year — roughly $25,600 over its six-year life in today's dollars. The cheaper sticker price was the expensive choice. Without EAC, most buyers pick Van A, replace it in year three, and never realize the "bargain" charged them a premium every single year.

Notice how much of the answer came from maintenance, not the purchase price. Van A's maintenance adds 65% to its lifetime cost in present value. Any comparison that ignores operating costs — fuel, power, consumables, service contracts — is not a comparison at all.

Replacement-Chain Thinking: The Idea Behind the Math​

If the formula feels like black magic, the replacement-chain method shows the same logic the long way around. To compare a 3-year van with a 6-year van, imagine a 6-year horizon: Van B serves it in one purchase, while Van A serves it as two consecutive purchases (years 1–3 and years 4–6). Compute the NPV of each 6-year chain and compare directly.

For Van A, the second purchase happens three years out, so its $50,000 price discounts to $37,566 today, and the second round of maintenance discounts similarly. Add it all up and the chain's NPV is about $144,000 versus Van B's $118,553 — Van B wins, exactly as EAC said. The two methods always agree, because EAC is the replacement chain compressed into one number per option. EAC just spares you from finding a common multiple of the lifespans, which gets miserable when one asset lasts 4 years and the other lasts 7.

The chain framing also makes the identical-replacement assumption visible. You assumed the year-four Van A costs the same $50,000 and performs the same. For a delivery van, fine. For a server, a camera body, or any equipment where next year's model is 30% cheaper or twice as capable, EAC overstates the case for the long-lived option — you would never actually chain identical replacements. When technology moves fast, shorten the assumed lives to the realistic replacement cycle, or compare over an explicit common horizon instead.

EAC vs. EAA: Costs and Benefits Are the Same Tool​

You may also meet the mirror image of this method: equivalent annual annuity (EAA), sometimes called equivalent annual benefit. It annualizes a project's NPV of net cash flows — revenues minus costs — instead of costs alone, and you pick the project with the highest EAA rather than the lowest EAC.

Use EAC when the options produce the same benefit and differ only in cost: two vans that haul the same loads, two ovens that bake the same bread. The revenue side cancels out, so costing alone decides. Use EAA when options generate different revenues — a standard oven versus a high-throughput oven that lets you take more orders. Same formula, same annuity factor; only the sign of what you are maximizing changes.

When the Cheaper Sticker Price Costs More Per Year​

The Van A trap has a pattern worth memorizing, because you will see it in almost every equipment category:

• Short life plus high upkeep. Budget equipment often pairs a low purchase price with expensive consumables and frequent service — printers and ink are the consumer cliché, but the same structure shows up in compressors, mowers, and point-of-sale hardware.
• Energy appetite. A cheap used refrigeration unit can draw twice the power of a modern one. At commercial electricity rates, the efficiency gap alone can exceed the purchase-price gap within two years.
• Downtime you do not invoice. If the cheaper machine breaks down twice as often, the repair bills show up in your books but the lost production days often do not. Add a realistic downtime cost to the operating figure before you annualize, or EAC will bless the unreliable option.
• Financing differences. A 0%-for-12-months offer on the expensive machine changes its PV of costs. Always run EAC on actual cash outflows — down payment plus each loan payment — not the sticker price.

Taxes belong in the calculation too, and they can flip close calls. Depreciation shields income: under Section 179 or bonus depreciation you may expense the full purchase immediately, which reduces the effective PV of costs for the pricier asset more than for the cheap one. Run the EAC twice — once pre-tax for intuition, once after-tax with depreciation shields and deductible operating costs — and decide on the after-tax number.

Tracking the Inputs: Your Books Feed the Formula​

EAC is only as honest as its inputs, and the operating-cost input is where small businesses guess most. The fix is structural: give each major asset its own corner of your chart of accounts so the lifetime cost assembles itself from real postings instead of memory.

In a plain-text ledger, that means one fixed-asset account per machine plus postings that tag every repair, service contract, and utility allocation to it. A purchase and a year's maintenance might look like this:

2026-01-05 * "Acme Machinery" "Delivery van A"
  Assets:Equipment:Van-A   50000.00 USD
  Assets:Checking
 
2026-03-14 * "Quick Lube Fleet" "Van A quarterly service"
  Expenses:Maintenance:Van-A   320.00 USD
  Assets:Checking

Twelve months of Expenses:Maintenance:Van-A postings give you the annual operating figure EAC needs — no estimates, no digging through card statements. If you keep your books this way, the Beancount documentation shows how to structure asset and expense accounts so per-asset reports fall out of a single query. When replacement time comes, you annualize from history rather than hope.

A Small-Business EAC Checklist​

You do not need finance software to use this. A spreadsheet and twenty minutes beat gut feel every time:

1. List the real options, including keeping the current asset one more year (its EAC is next year's operating cost plus the forgone salvage value, annualized over one year).
2. Set the lifespan of each to the realistic replacement cycle, not the warranty period or the manufacturer's fantasy. Ask other owners what they got.
3. Gather lifetime costs: purchase price, installation, annual operating and maintenance, energy, insurance differences, and salvage value at the end.
4. Pick your discount rate — your borrowing rate or hurdle rate, applied consistently to all options.
5. Compute PV of costs, then divide by the annuity factor (or use PMT). Lowest EAC wins.
6. Stress-test the winner. Re-run with maintenance 25% higher and the lifespan one year shorter. If it still wins, buy with confidence; if the ranking flips, your decision is really a bet on those assumptions, and you should know that before you sign.

The van story generalizes to every lumpy purchase a small business makes: the $400 printer versus the $900 one, the budget laptop fleet versus business-grade machines, the cheap lease space with a punishing utility bill. Sticker prices shout and lifetimes whisper, so the wrong option usually looks like a bargain right up until you annualize. Run the EAC, and let the per-year number — not the price tag — decide.