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).

Annuity
A financial product that pays out a fixed stream of payments ... 
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, ... 
Discounted Cash Flow  DCF
A valuation method used to estimate the attractiveness of an ... 
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 ...

What is the difference between issued share capital and subscribed share capital?
The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >> 
How can I find net margin by looking a company's financial statements?
In finance and accounting, financial statements represent the fundamental means of analyzing a company's financial position, ... Read Full Answer >> 
What can working capital turnover ratios tell a trader?
A company's working capital turnover ratio is traditionally positively correlated with business performance. A high, or better ... Read Full Answer >> 
What is a negative writeoff?
A negative writeoff is a writeoff conducted by a company or accountant after deciding not to pay back an individual or ... Read Full Answer >> 
What metrics can be used when evaluating a telecommunications company to ensure its ...
Cash flow analysis has been transformed since the widespread introduction of statements of cash flow, and investors have ... Read Full Answer >> 
How do you record adjustments for accrued revenue?
An accountant records adjustments for accrued revenues through debit and credit journal entries in defined accounting periods ... Read Full Answer >>

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 News
The Financial Singularity Will Destroy Your Return
Given the current and future growth of financial technology, many believe algorithms will soon define what drives market outcomes. With a wealth of big data, algorithms would be able to create ... 
Fundamental Analysis
Explaining the Common Size Income Statement
A common size income statement expresses each account as a percentage of net sales. 
Professionals
What Does an Auditor Do?
An auditor ensures that organizations maintain accurate and honest financial records. 
Fundamental Analysis
Calculating the Net Debt to EBITDA Ratio
Financial analysts typically use the net debt to EBITDA ratio to determine a company’s ability to pay its debt.