ACCA Financial Management (F9) Certification Practice Exam

What does Equivalent Annual Cost (EAC) represent in investment decisions?

1. The total costs of a project divided by its lifespan

2. The total revenue expected from a project

3. The net present value of costs over the life of the project

4. The internal rate of return of a project

The correct answer is: The net present value of costs over the life of the project

The concept of Equivalent Annual Cost (EAC) serves as a useful approach in investment decisions to evaluate the cost of owning and operating a project over its lifespan on an annual basis. EAC represents the net present value of all costs associated with a project, converted into an annual figure. This allows for a direct comparison of projects with different lifespans and cash flow patterns. By focusing on costs in this way, EAC helps decision-makers to simplify complex analyses and understand the annual financial burden of a project. It essentially breaks down the total costs into a uniform annual cost, which can be particularly useful when assessing multiple projects or equipment options that may not have the same duration or timing of cash flows. In investment analysis, comparing projects based on EAC can lead to more informed decisions, especially when up against different durations or capital expenditure requirements. The method is particularly useful for capital budgeting decisions, enabling companies to identify which projects deliver equivalent annual costs that provide the best financial return relative to their business strategy.