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- 2070 Bhadra · 4+8 marks
Reasons for replacement; strategy from AEC table
Short answer
Replacement reasons include physical deterioration, obsolescence, inadequacy, changed requirements, and financial factors. With AECs at 12% MARR, defender ESL=2 years (AEC 5,250), challenger ESL=4 years (5,600). Best strategy: use defender for 3 years, then challenger for 5 years, PW Rs 27,531 (annualized Rs 5,542).
Explain about the reasons for replacement of asset. The Annual Equivalent Cost (AEC) of the defender and challenger are given in the table below. What is the best replacement strategy? Use MARR = 12%. The planning horizon of the project is 8 years.
| End of Year (n) | 1 | 2 | 3 | 4 | 5 | 6 |
|---|---|---|---|---|---|---|
| (AEC)D | 5300 | 5250 | 5400 | 5750 | 6200 | 6550 |
| (AEC)C | 7700 | 6150 | 5700 | 5600 | 5675 | 5800 |
Reasons for replacement of an asset
- Physical deterioration: wear raises repair, maintenance and downtime costs and cuts efficiency.
- Obsolescence: newer technology gives the same output at lower cost or with better quality.
- Inadequacy: the old asset can no longer meet the required capacity or demand.
- Changed requirements: new laws, safety rules, or a change in the product.
- Financial reasons: lease-versus-buy, tax advantages, or the high resale value of the old asset now.
Replacement strategy (MARR = 12%, 8-year horizon)
Economic service lives from the table: defender minimum AEC = 5,250 at n = 2; challenger minimum AEC = 5,600 at n = 4. Because the planning horizon (8 years) is finite and the tables stop at 6 years, each plan is "defender for n years, then challenger(s) for the remaining years".
PW = AEC_D(n)(P/A,12%,n) + AEC_C(m)(P/A,12%,m)(P/F,12%,n)
Example, defender 3 years then challenger for 5 years:
PW = 5,400(P/A,12%,3) + 5,675(P/A,12%,5)(P/F,12%,3)
= 5,400(2.4018) + 5,675(3.6048)(0.7118) = 12,970 + 14,562 = 27,531
| Defender kept | Then challenger(s) for | PW of cost | Equivalent AEC (8 yr) |
|---|---|---|---|
| Defender 3 yr | 5 yr | 27,531 | 5,542 |
| Defender 2 yr | 3 + 3 yr | 27,555 | 5,547 |
| Defender 1 yr | 4 + 3 yr | 27,687 | 5,574 |
| Challenger only | 4 + 4 yr | 27,819 | 5,600 |
| Defender 4 yr | 4 yr | 28,274 | 5,692 |
| Defender 5 yr | 3 yr | 30,118 | 6,063 |
| Defender 6 yr | 2 yr | 32,196 | 6,481 |
The minimum PW is Rs 27,531 (about Rs 5,542 per year). The next plan, defender 2 years then challenger 3 + 3, is only 24 higher, so the two plans are practically equal.
Answer: Keep the defender for 3 years, then replace it with the challenger and keep the challenger for the remaining 5 years. (Replacing after its 2-year economic life is almost as good.)
✓ Answer checked by Claude Opus 5.5 (high effort)
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