Session 29

Economic Life of Defender and Challenger

7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Problem 9-5 (Economic Life of Challenger)

In a replacement analysis for a vacuum seal on a spacecraft, the
following data are known about the challenger:
The initial investment is $12,000
There is no annual maintenance cost for the first three years, however, it will
be $2,000 in years four and five, and then $4,500 in the sixth year and
increasing by $2,500 each year thereafter.
The salvage value is $0 at all times
The MARR is 10% per year.

What is the economic life of the challenger?

7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Problem 9-5 (Economic Life of Challenger)

EOY Cash Flow
0
-12000
1
0
2
0
3
0
4
-2000
5
-2000
6
-4500
7
-7000
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PW
-12000
0
0
0
($1,366.03)
($1,241.84)
($2,540.13)
($3,592.11)

EUAC
($13,200.00)
($6,914.29)
($4,825.38)
($4,216.59)
($3,853.52)
($3,937.31)
($4,260.13)

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Economic Life
Proper analysis requires knowing the economic life (minimum EUAC)
of the alternatives.
The EUAC of a new asset can be computed if the capital investment,
annual expenses, and year-by-year market values are known or can
be estimated.
The difficulties in estimating these values are encountered in most
engineering economy studies, and can be overcome in most cases.

In this course, we will focus on understanding the concepts of

economic life (the calculation becomes extremely messy and timeconsuming).
7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Economic Life (minimum EUAC)

Finding the EUAC of the challenger requires finding the total marginal
cost of the challenger, for each year. The minimum such value
identifies the economic life.
The equation below represents the present worth, through year k, of
total costs. (Although the sign is positive, it is a cost. Eq. 9-1.)

7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Total Marginal Cost

The total marginal cost is the equivalent worth, at the end of year k,
of the increase in PW of total cost from year k-1 to year k.

This can be simplified to (eq. 9-2):

7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Economic Life of Challenger (example)

7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Economic Life of Challenger (example)

7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Economic Life of Defender

If a major overhaul is needed, the life yielding the minimum EUAC is
likely the time to the next major overhaul.
If the MV is zero (and will be so later), and operating expenses are
expected to increase, the economic life will be the one year.
The defender should be kept as long as its marginal cost is less than
the minimum EUAC of the best challenger.

7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

Replacement Cautions
In general, if a defender is kept beyond where the TC exceeds the
minimum EUAC for the challenger, the replacement becomes more
urgent.
Rapidly changing technology, bringing about significant improvement
in performance, can lead to postponing replacement decisions.
When the defender and challenger have different useful lives, often
the analysis is really to determine if now is the time to replace the
defender.
Repeatability or cotermination can be used where appropriate.
7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

10

After-Tax Replacement
Taxes can affect replacement decisions.
Most replacement analyses should consider taxes.
Taxes must be considered not only for each year of operation of an
asset, but also in relation to the sale of an asset.
Since depreciation amounts generally change each year, spreadsheets
are an especially important tool to use.
7/28/2014

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

11

Replacement (example)
Given the following information, what is the most economical time to
replace the defender?
Challenger:
Defender:

7/28/2014

EUAC

TC

$20,000

$17,000

$19,000

$17,300

$18,000

$17,600

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

12

Replacement (example)
The minimum EUAC of the Challenger is never less than the TC of the
Defender, so we dont replace!
Challenger:
Defender:

7/28/2014

EUAC

TC

$20,000

$17,000

$19,000

$17,300

$18,000

$17,600

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

13

Replacement (example)
Given the following information, what is the most economical time to
replace the defender?
Challenger:
Defender:

7/28/2014

EUAC

TC

$18,800

$17,000

$18,000

$17,300

$17,200

$17,600

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

14

Replacement (example)
Since the minimum EUAC of the Challenger is less than the TC of the
Defender by Year 2, we replace the Defender in Year 2.
Challenger:
Defender:

7/28/2014

EUAC

TC

$18,800

$17,000

$18,000

$17,300

$17,200

$17,600

IE 343, Summer 2014, Engineering Economy (Sullivan, 16th)

15