The Accounting Historians Journal Vol. 9, No. 1 Spring 1982
Thomas W. Jones
UNIVERSITY OF ARKANSAS
J. David Smith WESTERN ILLINOIS UNIVERSITY
AN HISTORICAL PERSPECTIVE OF NET PRESENT VALUE AND EQUIVALENT ANNUAL COST
Abstract: Net present value and equivalent annual cost are two discounted cash flow criteria for comparing investment proposals. Why have accountants taken to net present value? Why do engineers readily use equivalent annual cost? This paper investigates the historical development of these principles to provide an explanation of why this is so.
Capital financing and budgeting represents a fundamental func-tion of management. In a recent paper, Truitt1 discussed the prob-lem of comparing investments with unequal lives by contrasting the traditional net present value (NPV) method with the equivalent annual cost (EAC) method. He indicated that the annual cost method appears in the engineering literature but apparently has not ap-peared in the accounting literature.
The purpose of this paper is to explain why engineers are con-versant with the EAC method while, for the most part, this method is unknown to accountants. This objective is accomplished by tracing the historical development of NPV and EAC.
The net present value and equivalent annual cost methods are members of the family of discounted cash flow criteria of invest-ment evaluation which have their modern-day foundation in actuarial science and the financial investment market of the nineteenth century.2 However, discounted cash flow criteria were not applied to nonfinancial investments until late in the century.3
In the net present value method, cash flows are discounted to the present while the equivalent annual cost method converts cash flows into an equivalent series of uniform annual amounts. NPV computations often result in a dollar amount of such considerable