DEFINITION of 'Equivalent Annual Annuity Approach  EAA'
One of two methods used in capital budgeting to compare mutually exclusive projects with unequal lives. The equivalent annual annuity (EAA) approach calculates the constant annual cash flow generated by a project over its lifespan if it was an annuity. The present value of the constant annual cash flows is exactly equal to the project's net present value (NPV). When used to compare projects with unequal lives, the one with the higher EAA should be selected.
INVESTOPEDIA EXPLAINS 'Equivalent Annual Annuity Approach  EAA'
The EAA approach uses a threestep process to compare projects:
 Calculate each project's NPV over its lifetime.
 Compute each project's EAA, such that the present value of the annuities is exactly equal to the project NPV.
 Compare each project's EAA and select the one with the highest EAA.
For example, assume that a company with a weighted average cost of capital (WACC) of 10% is comparing two projects, A and B. Project A has a NPV of $3 million and an estimated life of five years, while Project B has a NPV of $2 million and an estimated life of three years. Using a financial calculator*, Project A has an EAA of $791,392.44, and Project B has an EAA of $804,229.61. Under the EAA approach, Project B would be selected since it has the higher equivalent annual annuity value.
The EAA approach is relatively easier to use rather than the other method used to compare projects with unequal lives, the replacementchain or common life approach.
*Note: Most financial calculators would use the following inputs:
Project A – N (project life) = 5, i (WACC) = 10%, PV = 3,000,000, FV = 0, compute PMT (the answer should be 791,392.44).
Project B – N (project life) = 3, i (WACC) = 10%, PV = 2,000,000, FV = 0, compute PMT (the answer should be 804,229.61).

Net Present Value  NPV
The difference between the present value of cash inflows and ... 
Cost Of Capital
The required return necessary to make a capital budgeting project, ... 
Internal Rate Of Return  IRR
The discount rate often used in capital budgeting that makes ... 
Discounted Cash Flow  DCF
A valuation method used to estimate the attractiveness of an ... 
Weighted Average Cost Of Capital ...
A calculation of a firm's cost of capital in which each category ... 
Annuity
A financial product sold by financial institutions that is designed ...

Active Trading
Evaluate Stock Price With ReverseEngineering DCF
This is a more accurate method to use when trying to find a target price for a stock. 
Investing Basics
DCF Valuation: The Stock Market Sanity Check
Calculate whether the market is paying too much for a particular stock. 
Options & Futures
Find Investment Quality In The Income Statement
Use these key attributes to uncover toplevel investments. 
Forex Education
Understanding The Income Statement
Learn how to use revenue and expenses, among other factors, to break down and analyze a company. 
Fundamental Analysis
Top 3 Pitfalls Of Discounted Cash Flow Analysis
The DCF method can be difficult to apply to reallife valuations. Find out where it comes up short. 
Investing
Peer Comparison Uncovers Undervalued Stocks
Learn how to put one of the top equity analysis tools to work for you. 
Taxes
What is the best method of calculating depreciation for tax reporting purposes?
Learn the best method for calculating depreciation for tax reporting purposes according to generally accepted accounting principles, or GAAP. 
Fundamental Analysis
Are accounts receivable used when calculating a company's debt collateral?
Learn how accounts receivables are recorded as assets on a balance sheet; they are used when calculating a company's total debt collateral. 
Retirement
Are annuities for seniors only?
Understand the benefits of investing in annuities at a younger age and how fixed or variable annuities might benefit the investor depending on risk tolerance. 
Retirement
What is a longevity annuity?
Understand all the characteristics of a longevity annuity contract, the purpose of a longevity annuity and what type of investor it appeals to.