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Equivalent annual annuity approachs

In capital budgeting, equivalent annual annuity (EAA) approach is used to analyse the constant annual money yield by a project over its life period. While calculating annual annuity Net present value (NPV) plays an important factor which is used to find the present value of an investment which has unequal money flow. By the way when we use to differentiate the projects which does not has same life, It is always better to select which has higher EAA. Time is considered as money, calculate your value of money or the investment through our annual annuity

How to decide on annual annuity? Equivalent Annual Annuity Approach (EAA) also help to make analysis of various projects and acts as a deciding factor before investing on a project. In all kind of financial investment assessment, it is very crucial and important to decide whether to proceed with current project or can it be focused on investing other project. EAA is used in capital budgeting to find the net present value of an investment. The present value of the constant annual cash flow is equal to the projects net present value.

How to Calculate Equivalent Annual Annuity Approach?

Formula:

C = r (NPV) / 1 - (1 + r)^-n


where,

  c - is the Equivalent Annual Annuity
NPV - is the net present value
  r - is the rate per period 
  n - is the number of periods.

Solved Example Problem: Lets consider the vales given as below sample EAA approach

Net Present Value (NPV) = 150,000
Rate Per Period (r) = 8 % , which is = 0.08 (8/100)
Number of periods(n) = 15 years 

Solution: Solved Problem

 = 0.08 *(150,000) / (1 - (1 + 0.08)<sup>-15</sup>)
 = 12000 / (1 - (1 + 0.08)<sup>-15</sup>)
 = 17,524.43

which returns an equivalent annual annuity of 17,524.43. You can calculate the EAA for minimum period, which gives more return in short term.