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a) We first determine the economic life for the challenger.

The calculations are shown in the


table below.
Sample calculations for the AEC of keeping the challenger for one, two, and three years are as
follows:
AEC (1 year) = (9500)(A/P, 12%, 1) - 8000 + 1000
= 3640
AEC (2 years) = (9500)(A/P, 12%, 2) 7000 (A/F,12%,2) + 1000
= 3319.25
AEC (3 years) = (9500)(A/P, 12%, 3) 6000 (A/F,12%,3) + 1000 + 200 (A/F,12%,3)
= 3236.5
End of year
1
2
3
4
5
6
7
8

Salvage value
8000
7000
6000
5000
4000
3000
2000
1000

Operating
Costs
AEC
1000
3640
1000 3319.25
1200
3236.5
1500 3233.07*
2000 3290.81
2000 3314.16
2000 3318.68
3000 3393.52

*Lowest annual equivalent cost.

Alternatively, one can find the marginal cost (MC) of keeping the challenger for one more year
for n=1,,8 and use the formulas below as we did for Tutorial 10 question (see the excel sheet
for an alternative solution)

Minimum AEC = 3233.07, and therefore economic life of the new generator = 4 years.
b) Next we determine the economic life for the defender. The calculations are shown in the table
below.
Sample calculations for the AEC of keeping the defender for one, two, and three years are as
follows:

AEC (1 year) = (2400)(A/P, 12%, 1) - 1400 + 2000


= 3288
AEC (2 years) = (2400)(A/P, 12%, 2) 980 (A/F,12%,2) + 2000 500 (A/F,12%,2)
= 2722
AEC (3 years) = (2400)(A/P, 12%, 3) 686 (A/F,12%,3) + 2000 500(F/P, 12%,1) (A/F,12%,3)
= 2630
Operating
End of year
Salvage value Costs
$1,400
$2,000
1
$980
$1,500
2
$686
$2,000
3
$480
$3,500
4
$336
$3,000
5
$235
$3,500
6
$165
$5,000
7
$115
$4,500
8
*Lowest annual equivalent cost.

AEC
$3,288
$2,722
$2,630
$2,872
$2,924
$3,013
$3,219
$3,329

Alternatively, one can find the marginal cost (MC) of keeping the defender for one more year for
n=1,,8 and use the formulas below as we did for Tutorial 10 question (see the excel sheet for
an alternative solution)

Minimum AEC = 2630, and therefore economic life of the existing generator = 3 years.
c) We see that, for an additional life of three years, the defender has a lower cost per year than
the challenger, when the challenger is kept over its economic life. Therefore, the defender should
not be replaced at this time.