Equivalent annual annuities

Another method to deal with the unequal life problem of projects is the equivalent annual annuity (EAA) method. In this method the annual cash flows under the alternative investments are converted into a constant cash flow stream whose NPV is equivalent to the NPV of the comparative projects initial stream.

Consider the case of Black Sheep Broadcasting:

Black Sheep Broadcasting is considering a four-year project that has a weighted average cost of capital of 11% and a net present value (NPV) of $75,682. Black Sheep Broadcasting can replicate this project indefinitely.

The equivalent annual annuity (EAA) for this project is .

The EAA approach to evaluating projects with unequal lives do a good job of taking inflation into account.