When should we replace something? At what point does the cost of the current equipment is higher than re-purchasing new tools?
Sometimes economic life is less than physical life (cost of operation is not worth even if something still not worn out). It is more economic to replace it with something else.
Defender is existing asset, challenger is the proposed replacement.
Issues to consider as our cost/benefits when doing replacement analysis:
We take the initial cost of the asset and the on-going cost, and we find the EUAC. The initial cost is spread over the life-time (reducing equivalent annual cost). The other hand is the increasing annual cost to maintain the asset.
So we’re trying to figure out the time where the EUAC is minimum.
initial cost of $15,000, annual costs $1,000 first year with $500 increase each year after.
Annual initial cost is the inital cost divided by years. The operating costs increases each year. The sum of the two is the total annual costs. Find the year such that this is minimum.
The result is a “bathtub” curve; we want to replace asset when the cost is minimum:
<img src=”assets/image-20180808204532891.png” width=40%>
The mariginal cost is the cost to keeping an asset for one more year. It includes:
Defender marginal costs are increasing:
Defender marginal costs are decreasing (early on in its useful life):
When we don’t know the marginal cost of defender:
Period: 10 years, interest rate is 11% per year.