Introduction

Businesses must regularly evaluate their assets (equipment, vehicles, etc.). For any asset, you have four choices:

1. Do nothing: Keep using it as-is.
2. Overhaul it: Improve its performance.
3. Retire it: Remove it without replacement.
4. Replace it: Swap it for a new asset.

Key Terminology

• Defender: The existing, currently-owned asset.
• Challenger: The potential new asset that could replace the defender.
• Economic Life: The number of years that results in the lowest total equivalent annual cost of owning and operating an asset. It's the optimal replacement period.

Equivalent Annual Cost (EAC)

• A method that converts all costs (purchase, maintenance, etc.) into a uniform annual amount. This allows for easy comparison between assets with different lifespans.

  $$ \text{EAC (capital costs)} = (P - S)(A/P, i, N) + (S × i) \newline \text{EAC(total)} = \text{EAC(capital costs)} + \text{EAC(operating + maintenance costs)} $$

EAC for Non-Uniform Cash Flows (O&M) Costs

1. Convert each year’s O&M cost to present worth
2. Sum all PW values
3. Convert back to annual equivalent $\text{Sum} \times (A/P,i,N)$

Fundamental Replacement Problem

The core of replacement analysis is a trade-off:

• Capital Costs: The cost of purchasing the asset, spread over its life. This cost decreases per year the longer you keep the asset.