Explore BrainMass

Equivalent Annual Method

When trying to determine between two seperate projects I understand that the EAM is the best tool. However I am not sure how to apply this.

I need to know in a step by step format how to calculate this and further how to use.

For example:

short-lived light bulbs last 2 years, cost is $5 and use of electricity is $5 annually
long-lived light bulbs last 5 years, cost is $10 and use $3 electricity annually

what would the true cost be if the discount rate = 10%?

Solution Preview

In EAM, we find the present value of the costs and then find the annuity value of these costs. To explain with your example.
The cash flow for the short lived bulbs are
Year 0 1 2
Amount 5 5 5
Using a discount rate of 10%, the present value of the cost is 5+5/1.1+5/(1.1)^2=13.68

For the long lived bulb the cash flows are
Year 0 1 2 3 4 5

Solution Summary

The solution explains how to use the Equivalent Annual Method when the lives of the projects differ.