Asset replacement
Asset replacement decision, is to decide how frequently an asset should be replaced. As the asset gets older, it may cost more to maintain and operate. Its residual value will decrease and it may lose some productivity/operating capability.
The most convenient method is the Equivalent Annual Cost.
-The NPV of the cost of buying and using the asset over its lifecycle is converted into an EAC or annuity.
-This is useful for calculating assets’ EAC with different length of life.
Key assumptions
Cash inflows from trading are not normally considered in this type of question. The assumption being that they will be similar regardless of the replacement decision.
The operating efficiency of machines will be similar with differing machines or with machines of differing ages.
In most questions tax and inflation are ignore
①Identify the cash flow only arising from the asset （excluding the trading cashflow）
②Calculate the PV of cash flow
③Calculate the EAC of each machine
EAC=PV ofthe cost over one replacement period / Annuity factor
④Compare the EAC and choose the lowest one
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