ACCA Financial Management (F9) Certification Practice Exam

What is the Equivalent Annual Cost (EAC)?

1. The total costs of ownership spread over the asset's life

2. The annuity cash flow equal to a project's future costs

3. The annuity cash flow amount equivalent to the present value of a project’s costs

4. A calculation used for assessing cash flow forecasts

The correct answer is: The annuity cash flow amount equivalent to the present value of a project’s costs

The Equivalent Annual Cost (EAC) is a concept used in capital budgeting to evaluate and compare the costs of different projects or assets that have varying lifespans. It represents the annuity cash flow amount that is equivalent to the present value of a project’s costs over its entire life. This helps in understanding how much a project will cost on an annual basis, making it easier to compare projects that may have different durations and cash flow patterns. When you calculate EAC, you convert the present value of total costs (which may include initial investment, operating costs, and maintenance costs) into an equal annual payment over the asset's useful life. This allows decision-makers to assess and compare the financial impact of multiple projects on a common annual basis. In contrast, other answer choices either misrepresent the essence of EAC or address different concepts. For instance, while the total costs of ownership spread over the asset's life focuses on total expenditures rather than the annualized costs, the annuity cash flow equal to a project's future costs might not effectively capture the present value aspect that EAC emphasizes. Similarly, while assessing cash flow forecasts is important in financial management, it does not specifically define EAC, which is a more targeted measure for financial comparison between assets