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Ishan Agarwal
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Intermediate
Asked: 2023-09-25T13:08:56+05:30 In:

Replacement project

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Replacement project

In Q.36 we are computing EAC and in Q.37, we are using NPV, reason being it is not a repetitive process. Isn’t Q36, also a one time thing? Shouldn’t we have used NPV?

(I want to know conceptually, not what ICAI provides as solution)

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    1 Answer

    1. Jyoti Jaiswal
      Pro

      In project evaluation and financial analysis, both Net Present Value (NPV) and Estimate at Completion (EAC) are important tools, but they serve different purposes and are applied in different contexts. Let’s break down their conceptual differences to understand why EAC is used in Q.36 and NPV in Q.37:

      1. Estimate at Completion (EAC): EAC is used to estimate the total cost of completing a project based on the current performance and expenses incurred up to a certain point. It is commonly used in project management to assess whether a project is on track in terms of cost. EAC considers the actual costs incurred so far and predicts the total cost needed to complete the project. It is used primarily for ongoing projects to anticipate if they will exceed their budget.
        • In Q.36, you are likely dealing with an ongoing project where you need to estimate the total cost required to complete it based on current performance and costs incurred. This is why EAC is used.
      2. Net Present Value (NPV): NPV, on the other hand, is used to evaluate the profitability of an investment or project over its entire life span. NPV takes into account all expected cash flows (both inflows and outflows) and discounts them to their present value using a predetermined discount rate. NPV is typically used to decide whether to invest in a project or not, and it considers the time value of money.
        • In Q.37, you may be evaluating the long-term financial viability of a project or investment, which is why NPV is used. NPV considers all the expected future cash flows and determines whether the project is expected to generate a positive or negative return over its entire life.

      So, conceptually, the choice between EAC and NPV depends on the context and what you are trying to assess:

      • EAC is used for estimating the remaining cost of an ongoing project based on its current performance.
      • NPV is used for evaluating the financial attractiveness of an investment or project over its entire life, considering both future inflows and outflows.

      In summary, the choice between EAC and NPV depends on whether you are concerned with project cost estimation (EAC) or long-term profitability analysis (NPV), and this determines their applicability in different scenarios.

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