Replacement and Economic
Service Life
Replacement Analysis
When to replace an asset, and what to replace it with?
Outsider’s Perspective…
What would it cost someone on the outside to perform
the same operation?
Relevant costs ONLY –
Costs common among all options are not considered.
Sunk costs are NOT relevant –
What you originally paid for it doesn’t matter, but …
what it is worth NOW does matter!
1
Reasons for Replacement
 Inadequacy – Doesn’t meet needs,
increased demand. May buy a duplicate
or replace with a larger asset.
 Obsolescence – Technological changes,
better equipment is available (e.g.,
computers)
 Economic Life – An asset at the end of
its economic life.
 Deterioration – There is just not enough
duct tape in the world to keep it going
longer.
2
Economic Life
• Must have an on-going need.
• Must replace with a ‘like’ asset.
• We will not incorporate inflation in
this analysis.
• Basic question is “How long to hold
or own an asset to minimize costs?”
• Must use Annual Equivalent !
3
Modeling Economic Life…
Two Types of Costs:
• Cost of Ownership –
what it costs to own an
asset for N years. (P & S)
• Cost of Operation –
what it costs to operate an
asset for N years. (O & M)
Convert both to an annuity (EAC)
4
Modeling Economic Life…
Total EAC = EAC of Ownership
+ EAC of Operation
Objective is to determine the
optimum number of years to
own an asset that minimizes
the Total EAC.
This is called the Economic
Service Life of the asset.
5
Conceptually…
Over time…
Cost of ownership typically
decreases.
Cost of operation typically
increases.
6
Annual Equivalent Cost ($)
EACTotal
EACOwnership
EACOperation
ESL
(N yrs)
Years (n)
7
Example 1
An asset with ongoing need costs $15 000. The
estimated salvage value starts at $11 000 and
decreases each year; the operating costs start at
$3 000 and increase annually.
The estimated operating cost and salvage value at
the end of each of the next 12 years is provided in
the next table.
Use a MARR of 10% per year, compounded
annually, to determine the economic service life
and resultant total EAC of the asset.
Start: If kept for N = 1 year,
EACownership =
EACoperation =
EACtotal =
8
Example (Cont)
Year
Salvage
Operating
EAC Own.
EAC Op.
Total EAC
1
11,000
3,000
5,500
3,000
8,500
2
8,000
3,500
4,833
3,238
8,071
3
6,000
4,100
4,219
3,498
7,717
4
5,000
4,800
3,655
3,779
7,434
5
4,000
5,600
3,302
4,077
7,379
6
3,000
6,500
3,055
4,391
7,446
7
2,500
7,500
2,818
4,719
7,537
8
2,000
8,600
2,637
5,058
7,695
9
1,500
9,800
2,494
5,407
7,901
10
1,000
11,100
2,379
5,765
8,144
11
700
12,500
2,272
6,128
8,400
12
500
14,000
2,178
6,496
8,674
Minimum Total EAC is $7 379, … therefore, ESL is 5 years!