Replacement Analysis Questions and Answers

Answer: C

Correct answer: sum of capital recovery and operating cost is least

The economic service life is where the total equivalent uniform annual cost reaches its minimum - the point at which the still-falling capital recovery is just offset by the rising operating cost. Minimising either component alone gives the wrong answer, since one is least at the longest life and the other at the shortest.

Answer: D

Correct answer: equal to its longest possible life

With no rising operating cost there is nothing to oppose the falling capital recovery, so the total annual cost decreases monotonically and is least at the longest life available. The minimum exists only when the two forces work against each other.

Answer: A

It comprises the interest lost on the market value, the fall in that market value over the year and that year's operating and maintenance cost. Comparing it with the challenger's minimum annual cost is the standard test.

Answer: B

Correct answer: less than the challenger's minimum equivalent annual cost

The one-more-year rule compares the cost of the next year of the defender’s service - its loss of market value, the interest on the value tied up, and its operating cost - with the best annual cost the challenger could achieve. If keeping it for another year costs less than the challenger’s best, keeping it is right.

Answer: C

Correct answer: until its marginal cost exceeds the challenger's minimum annual cost

Where the marginal cost rises steadily, the test can simply be repeated year by year, and the crossing point is the year to replace. The rule depends on that monotonic rise: if the marginal cost falls again in a later year, the first crossing may not be the right answer and a full comparison over the whole life is needed.

Answer: D

A marginal cost that dips in some later year could be missed by a one-year test, so the defender's own economic service life and its annual cost over that life must be worked out. The comparison is then on a like basis.

Answer: A

Correct answer: minimum equivalent uniform annual cost over its economic life

The challenger is represented by the best it can do - its annual cost evaluated at its own economic service life, not at some arbitrary horizon. Using its first-year or final-year cost would compare the defender against a challenger operated inefficiently, which is not the alternative actually available.

Answer: B

Correct answer: challenger is being considered

Abandonment asks whether to continue the service at all, so the comparison is between keeping the asset and disposing of it, with nothing proposed in its place. Replacement asks which asset should provide a service that will continue either way. Discount rate, market value and operating costs all figure in both.

Answer: C

Correct answer: the challenger's economic life is used as a perpetual cycle

Comparing assets of unequal life on an annual cost basis implicitly assumes each is repeated indefinitely at its own economic life, so that the annual figures are directly comparable. The assumption is usually harmless but should be recognised, particularly where technology is changing fast enough that no identical replacement will exist.

Answer: D

Correct answer: raising the challenger's future first cost

Inflation makes deferral more expensive: a challenger costing 200,000 today will cost more in two years, and that increase is a genuine cost of keeping the defender longer. The analysis must be consistent throughout - either all cash flows in current terms with a real rate, or all in future terms with a nominal one.