Equivalent annual costs - part 2

In this lesson

1. 0:00 Optimum replacement cycle overview
2. 3:02 Calculating equivalent annual cost
3. 5:54 Two-year replacement cycle analysis
4. 8:23 Three-year replacement cycle comparison
5. 10:16 Key limitations of equivalent annual costs
6. 12:03 Applying EAC limitations to real scenarios

About this lesson

You'll work through a practical example involving a supermarket's delivery fleet, calculating whether it's most cost-effective to replace vehicles annually, every two years, or every three years by converting different replacement cycles into comparable annual costs. The core methodology involves calculating the present value of all costs and disposal proceeds for each potential replacement cycle, then dividing by the appropriate annuity factor to convert that into an equivalent annual cost. This allows you to compare cycles of different lengths on a like-for-like basis. You'll see how to handle both outflows (purchase price and running costs) and inflows (disposal proceeds), discount them correctly at the company's cost of capital, and interpret the results to identify the lowest-cost option. The lesson also explores the important limitations of equivalent annual costs that you need to recognise in exams. While the technique is powerful, it assumes assets will be replaced indefinitely with identical models, ignores inflation impacts, overlooks technological obsolescence, and doesn't account for changes in operational effectiveness due to wear and tear. Understanding these constraints helps you apply the technique appropriately and discuss its validity in case study scenarios where strategic or environmental factors might override the purely financial analysis.

Duration: 17m