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, ... 
Capital Budgeting
The process in which a business determines whether projects such ... 
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 ... 
Discounted Cash Flow  DCF
A valuation method used to estimate the attractiveness of an ...

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. 
Investing
What does DDP Mean?
Delivery duty paid (DDP) is a shipping term specifying that the seller is responsible for all costs associated with delivery of the goods to the buyer. It is usually used when goods are exported ... 
Fundamental Analysis
What is a good interest coverage ratio?
Learn the importance of the interest coverage ratio, one of the primary debt ratios analysts use to evaluate a company's financial health. 
Fundamental Analysis
What is a bad interest coverage ratio?
Understand how interest coverage ratio is calculated and what it signifies, and learn what market analysts consider to be an unacceptably low coverage ratio. 
Active Trading Fundamentals
What is liquidity risk?
Learn how to distinguish between the two broad types of financial liquidity risk: funding liquidity risk and market liquidity risk.