Annual

Equivalence
Analysis
Prepared by:

Eng. Abdulaziz Al-Zahrani

 Topics to be covered

⊷ Annual-Equivalence Worth Criterion

⊷ Applying Annual-Worth Analysis

⊷ Comparing Mutually Exclusive Projects

 Objectives

⊷ Applying the Annual Equivalence (AE) analysis to evaluate potential

projects
⊷ Calculate the Capital-Recovery Cost (CR) and to differentiate it from
Operating Costs
⊷ Apply AE analysis for determining some features of the project such as
‘per-unit cost’ and making decisions such as ‘Make-or-Buy’ decisions
⊷ Compare Mutually Exclusive Alternatives (projects) under different
service life situations based on AE analysis
6.1 Annual-Equivalence Worth
Criterion
 How to Determine the Operating Cost
per Hour?

⊷ Two different brands of refrigerator

 Purchase cost: Brand A Brand B
 Brand A: $799
 Brand B: $699
 Annual operating cost:
 Brand A: $55/year $799 $699
 Brand B: $85/year $55/Year $85/Year
 Service life: 25 years
 Salvage value: 0
 Annual Worth Analysis

⊷ Principle: Measure an investment worth on annual basis

⊷ Benefit: By knowing the annual equivalent worth, we can:
 Seek consistency of report
 Determine the unit cost (or unit profit)
 Facilitate the unequal project life comparison
 Process of Calculating the AE Value

0 1
2 3 4 5 6 7 8 9
10
PW(i)
Project Cash Flow

AE
( i)
=P 0 1 2 3 4 5 6 7 8 9 10
W
( i) Equivalent Annual Cash Flow
(A
/P
, i,
N) ISE 307 - Term 192
 Annual Worth Analysis

⊷ AE worth criterion provides a basis for measuring investment worth by

determining equal payments on annual basis. Knowing that any lump-sum
cash amount can be converted into a series of equal annual payments
⊷ Find the net present worth of the original series and then multiply this
amount by the capital-recovery factor:
AE (i) = PW (i) * (A/P, i, N)
⊷ We use this formula to evaluate the investment worth of projects
⊷ Therefore, AE criterion provides basis for evaluating a project that is
consistent with the PW criterion
 Annual Worth Analysis

⊷ Single Project Evaluation: the accept-reject decision rule for a single

revenue project is as follows:
 If AE(i) > 0, accept the investment.

 If AE(i) = 0, remain indifferent to the investment

 If AE(i) < 0, reject the investment

⊷ Comparing Mutually Exclusive Alternatives:

 Service projects: select the alternative with the minimum annual

equivalent cost
 Revenue projects: select the alternative with the maximum AE(i)
 Example 6.1: Finding Annual Equivalent
Worth

A hospital uses four coal-fired boilers to supply steam for space heating,
domestic hot water, and the hospital laundry. One boiler is operated at times of
low load and at weekends, two are operated during the week, and the fourth
boiler is normally off-line. The design efficiency on a steady load is generally
about 78%. The boilers at the hospital were being run at between 70% and 73 %
efficiency, due to inadequate instrumentation and controls. Engineers have
proposed that the boiler controls be upgraded. The upgrade would consist of
installing variable speed drives for the boiler fans and using the fans in
conjunction with oxygen trim equipment for combustion control.

The cost of implementing the project is $159,000. The boilers have a remaining
service life of 12 years. Any upgrade will have no salvage value at the end of 12
years.
 Example 6.1: Finding Annual Equivalent
Worth

The annual electricity use in the boiler house is expected to be reduced from
410,000 kWh to 180,000 kWh as a result of variable speed control of the boiler
fan (because with the variable speed drives, the fan motor draw only the power
actually required to supply air to the boilers). This is equivalent to $14,000 per
year. This savings is expected to increase at annual rate of 4% as the cost of
electricity increases over time.

Coal use will be 2% lower due to the projected improvement in boiler efficiency.
This corresponds to a cost reduction of $40,950 per year. This savings is
projected to increase as the coal price increases at an annual rate of 5%. If the
hospital uses a 10% interest rate for any project justification,

What would be the annual equivalent energy savings due to the

improvement?
Example 6.1: Finding Annual Equivalent
Worth
Solution: Since energy savings are in two
different geometric gradient series, we
calculate the equivalent present worth in
the following steps:
Savings in electricity :
PSavings in electricity= $14,000 (P/A1, 4%, 10%,
12) 1  (1  0.04)12 (1  0.10) 12 
P  $14,000  
 0.10  0.04 

P = $114,301

Savings in coal usage

PSavings in coal usage= $40,950 (P/A2, 5%,
10%, 12)
1  (1  0.05)12 (1  0.10) 12 
P  $40,950  
 0.10  0.05 
Computing equivalent annual
worth P = $350,356
 Example 6.1: Finding Annual Equivalent
Worth
Solution:
Net present worth calculation:
PW(10%) = $114,301 + $350,356 - $159,000 = $305,657

Since PW(10%) > 0 the project would be acceptable

Now, spreading the NPW over the project life gives

AE(10%) = $305,657 (A/P, 10%, 12) = $44,870 Net annual benefit

Since AE(10%) > 0, the project is also worth undertaken

The positive value indicates that the project is expected to bring in a net annual benefit of $44,870 over
the life of the project.
 Benefits of AE Analysis
⊷ AE is used when it is more useful to present annual cost or benefit of an
ongoing project rather than its overall cost or benefit

⊷ Some typical situations include:

When life-cycle-cost analysis is desired
When there is a need to determine unit costs or profits
When project lives are unequal
 Annual Equivalent Worth
with Repeating Cash Flow Cycles

i = 10% $800 $800

$700 $700
$500
$400 $400 $500 $400 $400

$1,000 $1,000

First Cycle Second Cycle

 Annual Equivalent Worth

Solution :
First Cycle:
PW(10%) = -$1,000 + $500 (P/F, 10%, 1)+ . . . + $400 (P/F, 10%, 5)
= $1,155.68
AE(10%) = $1,155.68 (A/P, 10%, 5) = $304.87

Both Cycles:
PW(10%) = $1,155.68 + $1,155.68 (P/F, 10%, 5)
= $1,873.27
AE(10%) = $1,873.27 (A/P, 10%,10) = $304.78
 Annual Equivalent Worth

⊷ When only costs are involved,

the AE method is called the annual equivalent cost

Annual Equivalent Cost

Capital
⊷ Revenues must cover two kinds of costs: costs
Operating costs and capital costs +

Operating
⊷ Normally, capital costs are nonrecurring costs
(i.e., one-time costs) whereas operating costs
recur for as long as an asset is being utilized.
 Capital (Ownership) Costs
⊷ Capital (Ownership) Costs are incurred by the purchase of assets to be
used in production and service.

⊷ Because capital costs tend to be one-time costs (buying and selling), when
conducting an annual equivalent cost analysis, we must translate these one-
time costs into their annual equivalent over the life of the project.

⊷ Suppose you purchased an equipment costing $10,000. If you keep the

asset for 5 years, your cost of owning the asset should include the
opportunity cost of $10,000. So, the capital cost is defined as the net cost of
purchasing (after any salvage value adjustment) plus the interest cost over
the life of the ownership.
 Capital (Ownership) Costs
⊷ The annual equivalent of a capital cost is given a special name: capital-recovery
cost, designated CR(i).

⊷ Two general monetary transactions are associated with the purchase and
eventual retirement of a capital asset: the asset's initial cost (I) and its salvage value
(S). Taking these amounts into account, we calculate the capital-recovery cost as
follows:

CR(i) = I (A/ P, i, N) - S(A/ F, i, N).

 Capital (Ownership) Costs
CR(i) =I (A/ P, i, N) - S(A/ F, i, N)

⊷If we recall the algebraic relationships between factors shown in Ch 2 and notice
that the (A/F, i, N) factor can be expressed as

(A/F,i,N) = (A/P,i,N) – i then we may rewrite the expression for CR(i) as

CR(i) = I(A/P,i,N) - S[(A/P,i,N) - i] = (I - S) (A/P, i, N) + iS

⊷ Basically, to obtain the machine, one borrows a total of I dollars, S dollars of

which are returned at the end of the Nth year.

⊷ The first term (I - S) (A/ P, i, N), implies that the balance (I - S) will be paid back in
equal installments over the N-year period at a rate of i, and the second term implies
that simple interest in the amount iS is paid on S until S is repaid.
 Capital (Ownership) Costs
ASKING PRICE AFTER 3
SEGMENT BEST MODELS PRICE YEARS
Compact car Mini Cooper $19,800 $12,078
Volkswagen
Midsize car Passat $28,872 $15,013

Sports car Porsche 911 $87,500 $48,125

Near luxury car BMW 3 Series $39,257 $20,806
Luxury car Mercedes CLK $51,275 $30,765
Minivan Honda Odyssey $26,876 $15,051
Subcompact SUV Honda CR-V $20,540 $10,681
Compact SUV Acura MDX $37,500 $21,375
Full size SUV Toyota Sequoia $37,842 $18,921
Compact truck Toyota Tacoma $21,200 $10,812
Full size truck Toyota Tundra $25,653 $13,083

Source: “Will your car hold its value? A New study does the math,” The Wall Street Journal, August 6, 2002
 Costs of Owning a Vehicle

Example: Capital Cost Calculation for Mini Cooper

Given: I=$19,800 , N=3 years , S=$12,078 , i=6%; Find: CR(6%)
Solution:
$12,078
CR (i ) = (I -S ) (A/P, i, N ) + iS
0
CR (6%) = ($19,800 - $12,078) (A/P, 6%, 3)
+ (0.06)$12,078 1 2 3
= $3,613.55
$19,800
 Annual Equivalent Worth Criterion
Example 6.3: Annual Equivalent Worth: Capital Recovery Cost
Ferguson Company is considering an investment in computer-aided design
equipment. The equipment will cost $110,000 and will have a five year useful
economic life. It has a salvage value of $10,000. The expected annual operating costs
for the equipment would be $20,000 for the first two years and $25,000 for the
remaining three years. Assume that Ferguson’s desired return on its investment
(MARR) is 15%, what is required annual savings to make the investment
worthwhile?

Given: I = $110,000, S = $10,000, N = 5 years, i = 15%

Find: AEC, and determine whether the firm should or should not purchase the
machine
 Annual Equivalent Worth Criterion
Example 6.3: Annual Equivalent Worth: Capital Recovery Cost

Solution:
Capital Costs: CR(i) = (I – S) (A/P, i, N) + i S
CR(i) = [($110,000 - $10,000) ( A/P, 15%, 5 ) + (0.15) x $10,000] = $31,332

Operating Cost:
OC (i) = [$20,000(P/A,15%,2) + $25,000(P/A,15%,3)(P/F,15%,2)] x (A/P,15%,5)
OC (i) = $22,573

Annual Equivalent Cost:

AEC(15%) = CR(15%) + OC(15%) = $31,332 + $22,573 = $53,905
The required annual savings must be at least $53,905 to recover the investment
made in the asset and cover the annual operating expenses.
 Practice Problem 1
Compute the annual equivalent worth of the following project cash flows at an
interest rate of 15%

Solution:
Equivalent annual payments of Benefits
= 100+(40(P/G,15%,4) +100(P/F,15%,5) +100(P/F,15%,6))(A/P,15%,6)
= 100+(40(3.7854)+100(0.4972)+100(0.4323))(0.2642)
= $164.567

Equivalent annual payments of Investment

= 300 (A/P, 15%, 6) = 300 X 0.2642 = $79.26

Annual equivalent worth = 164.567 - 79.26 = $85.307

 Practice Problem 2

You purchased an industrial robot at $200,000 to automate a part of

manufacturing process in your assembly line. If the robot will be used for 10
years and the expected salvage value of the robot is 10% of the initial cost,
what would be the capital cost of owning the robot at an interest rate of
15%?

Solution:
Capital Costs: CR(i) = ( I – S ) ( A / P, i, N ) + i S
CR(i) = [($200,000 - $20,000) ( A/P, 15%, 10 ) + (0.15) x $20,000]
CR(i) = [($200,000 - $20,000) ( 0.1993) + (0.15) x $20,000]
CR(i) = 35874 + 3000= $38,574
6.2 Applying Annual-Worth
Analysis
 Applying Annual-Worth Analysis

⊷ What is the Annual Equivalent Worth Criterion?

⊷ Applying Annual Worth Analysis

 Unit Cost (Unit Profit) Calculation

 Make or Buy Decision

 Unit Cost (Unit Profit) Calculation

⊷ In many situations, we need to know the unit profit or unit cost of operating
an asset. To obtain a unit profit (or cost), we may proceed as follows:
1. Determine the number of units to be produced (or serviced) each year
over the life of the asset
2. Identify the cash flow series associated with production or service
over the life of the asset.
3. Calculate the present worth of the project’s cash flow series at a given
interest rate, and then determine the equivalent annual worth
4. Divide the equivalent annual worth by the number of units* to be
produced or serviced during each year.
*When the number of units varies each year, you may need to convert the
units into equivalent annual units
 Example 6.4: Unit Profit per Machine
Hour

A firm is looking into investing in a robot to avoid workers accidents.

The investment will cost $1m and the salvage value is $100,000 after 5
years of service life. The robot will reduce labor costs, insurance,
accidents , … etc. The savings are $800,000 per year. Additional annual
operating and maintenance costs amount to $300,000. Suppose that the
robot will operate for 2,000 hours per year

Compute the equivalent savings per machine-hour at i = 15%

Example 6.4: Unit Profit per Machine
Hour
Example 6.4: Unit Profit per Machine
Hour
 Example 6.4: Unit Profit per Machine
Hour

A firm is looking into investing in a robot to avoid workers accidents.

The investment will cost $1m and the salvage value is $100,000 after 5
years service life The robot will reduce labor costs, insurance, accidents
, … etc. The savings are $800,000 per year. Additional annual operating
and maintenance costs amount to $300,000

Suppose that the robot will be operated according to varying hours:

1,500 hours in the first year, 2,500 hours in the second year and third
year, 2,000 hours in the fourth year, and 1,500 hours in the 5th year.
The total number of operating hours is still 10,000 over 5 years
Compute the equivalent savings per machine-hour at i = 15%
 Example 6.4: Unit Profit per Machine
Hour

SOLUTION:
Let C denote the equivalent annual savings per machine-hour that need to be
determined. Now, with varying annual usages of the machine, we can set up the
equivalent annual savings as a function of C:

Equivalent annual savings = C [(1,500) ( P /A, 15%,5) + ( 1,000)(P/A, 15%,2)

(P/F,15%, 1) + (500)(P/F,15%,4)] (A/P,15%,5) = 2,006.99 C

We can equate this amount to $216,516 and solve for C. This operation gives us
C = $216,516/2,006.99 = $107.88/hour, which is about $0.38 less than in the
situation of equal operating hours.
 Make or Buy Decision

⊷ Make or buy problems are among the most common business decisions. At
any given time, a firm may have the option of either buying an item or
producing it
⊷ Since the cost of an outside service (the “buy” alternative) is usually quoted in
terms of dollars per unit, it is easier to compare the two alternatives if the
differential costs of the “make” alternative are also given in dollars per unit
⊷ This unit cost comparison requires the use of annual worth analysis
 Example 6.6: Unit Cost : Make or Buy

B & S Company manufactures several lines of pressure washers. (pressure

washer is a high-pressure mechanical sprayer that can be used to remove loose
paint, mold, grime, dust, mud, and dirt from surfaces and objects such as
buildings, vehicles, concrete surfaces). One unique part, an axial cam a device
used to transform the rotary motion of the motor/ engine into the reciprocating
motion of a pump's pistons) requires specialized tools that need to be replaced.
Management has decided that the only alternative to replacing these tools is to
acquire the axial cam from an outside source. B & S’s average usage of the axial
cam is 120,000 units each year over the next five years
 Buy Option: A supplier is willing to provide the axial cam at a unit sales

price of $35 if at least 100,000 units are ordered annually.

 Example 6.6: Unit Cost : Make or Buy

 Make Option: If the specialized tools are purchased, they will cost
$2,200,000 and will have a salvage value of $120,000 after their expected
economic life of five years. With these new tools, the direct labor and
variable factory overhead will be reduced, resulting in the following
estimated unit production cost:
Direct material $8.50
Direct labor $5.50
Variable factory overhead $4.80
Fixed factory overhead $7.50
Total unit cost $26.30

 Assuming that the firm’s interest rate is 12%, calculate the unit cost under
each option and determine whether the company should replace the old
tools or purchase the axial cam from an outside source.
 Example 6.6: Unit Cost : Make or Buy

Financial Facts:
Annual volume = 120,000 units

Buy Option: Unit price = $35

Buy option is just 35x120,000=4.2m
Make Option:
Required Investment in specialized tools: $2.2M,
Service life = 5 years,
Salvage value = $0.12M
Variable production cost: $26.30 per unit

Annual production cost is 26.30 x 120,000 = 3,156,000

 Example 6.6: Unit Cost : Make or Buy

Capital Cost:
CR(12%)=($2,200,000-$120,000)(A/P,12%,5)+(.12)($120,000)=$591,412

Production Cost: OC(12%) = ($26.30/unit) x (120,000) = $3,156,000/year

Total Annual Equivalent cost is:

AEC(12%)=$591,412+$3,156,000 = $3,747,412

Make Option: Unit Cost = $3,747,412 / 120,000 = $31.23 / unit 

$35.00 – $31.23 = $3.77 / unit saving by making axial cam in house
$3.77 x 120,000 = $452,400 saving per year
6.3 Comparing Mutually
Exclusive Projects
 Life-Cycle Cost Analysis

⊷ An Issue: To compare different design alternatives, each of which would

produce the same number of units (constant revenues), but would
require different amounts of investment and operating costs
 This is known as life-cycle cost analysis (the total cost over project period)

⊷ What to do: Compute the annual equivalent cost of the design

alternatives over the entire service life and select the alternative with
the least cost
 Example 6.7: Life-Cycle Cost Analysis

Standard
Motor Premium Efficient Motor

Size (Power output) 18.65kW 18.65kW

Initial Cost $13,000 $15,600
Life 20 years 20 years
Salvage $0 $0
Efficiency 89.5% 93%
Energy Cost $0.07/kWh $0.07/kWh
3,120
Operating Hours 3,120 hrs./year
hrs./year

(a) At i = 13%, determine the operating cost per kWh for each motor.
(b) What is the number of operating hours per year that would make the
two types of motors equally economical?
 Example 6.7: Life-Cycle Cost Analysis

Solution:
Step 1: Calculate the Required Input Power
(a) Operating cost per kWh:
Determine the required input power: Required input power= Desired output power
% efficiency
 Conventional motor:

input power = 18.65 kW/ 0.895 = 20.838kW

 PE motor:

input power = 18.65 kW/ 0.93 = 20.054kW

 Example 6.7: Life-Cycle Cost Analysis

Solution:
Step 3: Determine the Total Equivalent Annual Cost
Determine the capital cost:
 Conventional motor: input power = $13,000(A/P, 13%, 20) = $1,851

 PE motor: input power = $15,600(A/P, 13%, 20) = $2,221

Determine the total annual equivalent cost:

 Conventional motor: AE(13%) = $4,551 + $1,851 = $6,402

Cost per kWh = $6,402/58,188 kWh = $0.11/kWh

 PE motor: AE(13%) = $4,380 + $2,221 = $6,601
Cost per kWh = $6,601/58,188 kWh = $0.1134/kWh
Clearly, conventional motors are cheaper to operate if the motors are expected to
run only 3,120 hours per year.
 Example 6.7: Life-Cycle Cost Analysis

Solution:
Step 4: Determine the savings (or loss) per operating hour obtained by
switching from conventional to PE motors.

Additional capital cost required switching from conventional

to PE motors:
Incremental capital cost = $2,221 - $1,851 = $370.
 Example 6.7: Life-Cycle Cost Analysis

Solution:
Step 4: Determine the savings (or loss) per operating hour obtained by
switching from conventional to PE motors.

Additional energy-cost savings switching from conventional to PE motors:

Incremental energy savings = $4,551 - $4,380 = $171

At 3,120 annual operating hours, it will cost the company an additional $370
to switch to PE motors, but the energy savings are only $171, which results in a
$199 loss from each motor.

In other words, for each operating hour, you lose about 6.38 cents.
 Example 6.7: Life-Cycle Cost Analysis

Solution:

(b) Break-Even Analysis

The break-even number of operating
Microsoft Excel
hours for the PE motors: 6,742 hours Worksheet

per year
1851 + 0.07 * 20.838 * # of Operating hours
2221 + 0.07 * 20.054 * # of Operating hours

Capital cost + energy cost * input energy

per hour * no. of hours
 Example 6.8: AEC Comparison – Unequal
Project Lives

MARR = 15%

Model A: $15,000
Required service Period
0 1 2 3
= Indefinite

$55,000 $55,000 $55,000 Analysis period =

LCM (3,5) = 15 years
$150,000

Model B: $35,000
0 1 2 3 4
5

$30,000 $30,000 $30,000 $30,000 $30,000

$230,000
 Example 6.8: AEC Comparison – Unequal
Project Lives $15,000
0 1 2 3

Solution:
$55,000 $55,000 $55,000
Model A: $150,000
⊷ For a three-year period (first cycle):

PW ( 15%)first cycle = -$150,000 - $55,000( P/A, 15%,3) + $15,000 (P/F, 15%,3)

= -$265,715
AEC (15%)first cycle = $265,715(A/P,15%,3) = $116,377

⊷ For a 15-year period (five replacement cycles):

PW ( 15%)15-year period = -$265,715[1 + (P/F,15%,3) + (P/F,15%,6) + (P/F, 15%,9) +
(P/F,15%,12)] = -$680,499
AEC (15%) 15-year period = $680,499(A/P,15%,15) = $116,377
 Example 6.8: AEC Comparison – Unequal
Project Lives $35,000
0 1 2 3 4
5

Solution: Model B: $30,000

⊷ For a five-year period (first cycle): $230,000

PW ( 15%)first cycle = -$230,000 - $30,000(P/A,15%,5) + $35,000(P/ F, 15%,5)

= -$313,163
AEC (15%)first cycle = $313,163(A/P,15%,5) = $93,422
⊷ For a 15-year period (three replacement cycles):
PW ( 15%)15-year period = -$313,163[1 + (P/F,15%,5) + (P/F,15%,10)) = -$546,270
AEC (15%) 15-year period = $546,270(A/P,15%,15) = $93,422

We can see that the AE cost of Model A is much higher ($116,377 > $93,422)  We
select model despite its higher initial cost
 Example 6.8: AEC Comparison – Unequal
Project Lives

Solution:
LCM = 15 years

AEC(15%)A = $116,377

Choose model B
AEC(15%)B = $93,422
 Practice Problem 3

⊷ The City has decided to build a baseball complex, and the city council has already
voted to fund the project at the level of $800,000 (initial capital investment). The
city engineer has collected the following financial information for the complex
project:
 Annual upkeep costs: $120,000

 Annual utility costs: $13,000

 Renovation costs: $50,000 for every 5 years

 Annual team user fees (revenues): $32,000

 Useful life: Infinite

 Interest rate: 8%

⊷ If the city can expect 40,000 visitors to the complex each year, what should be the
minimum ticket price per person so that the city can break-even?
 Practice Problem 3

Solution:
 Practice Problem 4

⊷ You have purchased an equipment costing $20,000. The equipment will be

used for two years, and at the end of two years, its salvage value is expected
to be $10,000. The equipment will be used 6,000 hours during the first year
and 8,000 hours during the second year. The expected annual net savings
will be $30,000 during the first year and $40,000 during the second year. If
your interest rate is 10%, what would be the equivalent net savings per
machine-hour?
 Practice Problem 4

Solution:
⊷ Capital cost: CR(10%) = ($20,000 - $10,000) (A/P, 10%,2) + (0.10)$10,000 = $6,762
⊷ Annual equivalent savings:
AE (10%)=[($30,000)/(1.1)+($40,000)/(1.1)^2 ](A/P,10%,2)= $34,762.48
⊷ Net annual savings = $34,762.48 − $6,762 = $28,000.48

Let C be the equivalent net savings per machine-hour

⊷ Net annual savings =[(C(6,000)/(1.1)+(C(8,000)/(1.1)^2 ](A/P, 10%,2) = 6,952.38C

Equate both equations: 6,952.38C = $28,000.48  C = $4.03 per hour

 Things to remember

⊷ Annual equivalent worth analysis AE(i) = PW{i) (A/P, i, N)

⊷AE analysis yields the same decision result as PW analysis.

⊷The capital-recovery cost factor, or CR(i), is one of the most

important applications of AE analysis in that it allows managers to
calculate an annual equivalent cost of capital for ease of
itemization with annual operating costs. The equation for CR(i) is
CR(i} = (I - S)(A/ P,i,N) + iS,
where I = initial cost and S = salvage value
 Things to remember

AE analysis is recommended over PW analysis in many key real-

world situations for the following reasons:
1. In many financial reports, an annual-equivalence value is
preferred for ease of use and its relevance to annual results

2. Calculation of unit costs is often required to determine sale price

3. Calculation of cost per unit of use is required to reimburse

employees for business use of personal cars.
 Things to remember

4. Make-or-buy decisions usually require the development of unit costs so

that "make" costs can be compared with prices for "buying.“

5. Comparisons of options with unequal service lives is facilitated by the AE

method, assuming that the future replacements of the project have
the same initial and operating costs. In general, this method is not
practical, because future replacement projects typically have quite
different cost streams. It is recommended that you consider various
future replacement.