Defender and Challenger Are IdenticaI

All long-lived assets eventually require replacement. Consequently, the issue in replacement studies is not ii hether to replace an asset, but when to replace it. In this section we consider the case where there is an ongoing need for a service provided by an asset and where the asset technology is not changing rapidly. (This is the case for Sergio's landscaping example at the beginning of this chapter.) Several assumptions are made.

1. The defender and challenger are assumed to be technologically identical. It is also assumed that this remains true for the company's entire planning horizon.

2. The lives of these identical assets are assumed to be short relative to the time horizon over which the assets are required.

3. Relative prices and interest rates are assumed to be constant over the company's time horizon.

These assumptions are quite restrictive. In fact, there are onlv a few cases where the assumptions strictly hold (cable used for electric power delivery is an example). Nonetheless, the idea of economic life of an asset is still useful to our understanding of replacement analysis.

Assumptions 1 and 2 imply that we may model the replacement decision as being repeated an indefinitely large number of times. The objective is then to determine a minimum-cost lifetime for the assets, a lifetime that will be the same for all the assets in the sequence of replacements over the company's time horizon.

We have seen that the relevant costs associated with acquiring a new asset are the capital costs, installation costs (which are often pooled with the capital costs), and operating and maintenance costs. It is usually true that operating and maintenance costs of assets—plant or equipment—rise with the age of the asset. Offsetting increases in operating and maintenance costs is the fall in capital costs per year that usually occurs as the asset life is extended and the capital costs are spread over a greater number of years. The rise in operating and maintenance costs per year, and the fall in capital costs per year as the life of an asset is extended, work in opposite directions. In the early years of an asset's life, the capital costs per year (although decreasing) usually, but not always, dominate total yearly costs. As the asset ages, increasing operating and maintenance costs usually overtake the declining annual capital costs. This means that there is a lifetime that will minimize the average cost (adjusting for the time value of money) per year of owning and using long-lived assets. This is referred to as the economic life of the asset.

These ideas are illustrated in Figure 7.1. Here we see the capital costs per period decrease as the number of periods the asset is kept increases because assets tend to depreciate in value by a smaller amount each period of use. On the other hand, the operating and maintenance costs per period increase because older assets tend to need more repairs and have other increasing costs with age. The economic life of an asset is found at the point where the rate of increase in operating and maintenance costs per period equals the rate of decrease in capital costs per period, or equivalently where the total cost per period is minimized.

Homeowners Guide To Landscaping

Homeowners Guide To Landscaping

How would you like to save a ton of money and increase the value of your home by as much as thirty percent! If your homes landscape is designed properly it will be a source of enjoyment for your entire family, it will enhance your community and add to the resale value of your property. Landscape design involves much more than placing trees, shrubs and other plants on the property. It is an art which deals with conscious arrangement or organization of outdoor space for human satisfaction and enjoyment.

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