CHAPTER-6: REPLACEMENT ANALYSIS
The economic life of the defender is often one year. Consequently, care must be taken
when comparing the defender asset with a challenger asset, because different lives are
involved in the analysis. We shall see that the defender should be kept longer than its
apparent economic life, as long as its marginal cost is less than the minimum EUAC of
the challenger over its economic life.
5. Income tax considerations
The replacement of assets often results in gains or losses from the sale of depreciable
property. Consequently, to perform an accurate economic analysis in such cases, the
studies must be made on an after-tax basis. It is evident that the existence of a taxable
gain or loss, in connection with replacement.
6.2 ECONOMIC SERVICE LIFE ANALYSIS
− The economic service life (ESL) is the number of years n* at which the equivalent
uniform annual worth (AW) of costs is the minimum. These AW values are cost
estimates, so the AW values are negative numbers. The ESL is often shorter than its
useful or physical life. When n* years have passed, the ESL indicates that the asset
should be replaced to minimize overall costs.
− To perform a replacement study correctly, it is important that the ESL of the challenger
and ESL of the defender be determined, since their n* values are usually not pre
established. Replacement is made only if EUAC of challenger is less than EUAC of
defender.
− Generally, defender involves a lower initial cost than that of purchasing challenger but
requires more annual operating cost due tot old technology and continues use. The total
Equal Uniform Annual Cost (EUAC) consists of the capital recovery and annual operating
cost of machine.
MGTS 301 (ENGINEERING ECONOMY), Kathmandu University
By Punya Ram Sujakhu (9841395153)
Page 2 of 6