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What Is an Equivalent Annual Cost?

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  • Written By: Mary McMahon
  • Edited By: Kristen Osborne
  • Last Modified Date: 16 December 2014
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The equivalent annual cost is the cost, per year, associated with the ownership, maintenance, and operation of an asset. This is an important consideration when decisions are being made about asset purchases and budgeting. People determine the equivalent annual cost by looking at the base price for the asset and the anticipated costs for maintenance and operation, and dividing them by the number of years the asset can be expected to be in service. For example, an asset expected to last five years that costs $100,000 United States Dollars (USD) and will cost $2,000 USD per year to operate will have an equivalent annual cost of $22,000 USD.

Usually, this is calculated when people are weighing purchasing choices. Knowing the equivalent annual cost for a single asset is useful as it will help people budget and make decisions, but it becomes especially critical when choosing between multiple assets. An asset that is very expensive may have a lower equivalent annual cost if it has a longer service life, for example. A company concerned about costs in the immediate future might be drawn to a less expensive asset, but find that pricing it out in comparison with other assets shows that it will be much more expensive in the long term.

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Companies that produce assets that could be considered major purchases can usually provide information about how much they cost to maintain, based on their experiences and the experiences of other customers. People can also rely on writeups about such products, as well as estimates from consultants. A company thinking about buying a new facility, for example, can ask a real estate agent about the annual maintenance costs they can expect, including taxes, insurance, and costs for keeping the facility in good repair.

The useful life of an asset is estimated on the basis of performance of similar assets and the design of the asset. Experts can provide people with information on the expected useful life of assets they are thinking about purchasing and people can also consider factors like product warranties. In addition, when estimating equivalent annual cost, people also have to think about the possibilities for a business to expand and grow, requiring early replacement of assets before their service lives are over.

While this concept usually comes up in business, ordinary individuals can apply it to their own lives. Equivalent annual cost is something to think about when buying cars, appliances, and other major purchases.

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SZapper
Post 3

@strawCake - That's a really good point. I bought an expensive vacuum cleaner about four years ago, and I've never spent a penny repairing it. However, most of my friends that buy the cheap vacuum cleaners end up replacing them all the time. I think over the last four years, they've probably spent more than I originally spent on my vacuum cleaner.

strawCake
Post 2

@indemnifyme - I'm pretty sure equivalent annual cost isn't meant to measure the cost of buying a pair of boots. That is pretty clever though, and boots don't even really need upkeep like a house does.

I do think that equivalent annual cost brings up a good factor though: how much something costs to maintain. For example, buying a really cheap car might not be really cheap in the long run. You will probably spend a lot more money on upkeep and repairs for a cheap car than you will for a nicer one.

indemnifyme
Post 1

Ok, so I'm a little embarrassed to admit this, but it seems that I've been using equivalent annual cost when I shop, and I've never heard of it before!

You see, when I buy something expensive (not something like a house though), I try to figure out what the equivalent cost would be if I used it every day for year, or a certain amount of time per week, or for a certain number of months.

For example, consider a $100 dollar pair of boots. If I wear them all the time during the winter (3 months), really I've only paid $33 a month for the pleasure of wearing the boots! And it becomes even less if I wear them the next year too. All of a sudden, the boots seem like a bargain!

I'm not sure this was the original intent of equivalent annual cost, but it sure makes me feel better sometimes.

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