Engineering Economic Analysis

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What Is the Basic Comparison? 417

arbitrarily subtract the disposition cost of the defender from the first cost of the challenger

, asset,for thispracticecan leadto an incorrectanalysis.

As described in Example 13-9, the correct first cost to assign to the defender SK-30

laptop is its $200 current market value. This value represents the present economic benefit

that we would beforgoingto keep the defender. This can be called ouropportunityfirst

cost.If, instead of assuming that this is anopportunity costto the defender, we assume

it is acash benefitto the challenger, a potential error arises. Consider the following case

involving the SK-30 and EL-40 laptops. Assume the following data:

Market value

Remaining life

SK-30

$200

3 years

First cost

Useful life

EL-40

$1050

3 years

In this case the remaining life of the defender (SK-30) is 3 years, and so is the useful

life of the challenger (EL-40). If we use anopportunity costperspective, then the calculated

capital recovery effect of first cost using an annual cost comparison is:

Annualized first coStSK-30=$200(Aj P,10%,3) = $80

Annualized first costEL-40=$1050(Aj P,10%, 3) = $422

Thedifferencein annualized first cost between the SK-30 and EL-40 is:

AFCEL-40 - AFCSK-30=$422 - $80=$342

Now use acashflowperspective to look at the first costs of the defender and challenger.

In this case we use the actual cash that changes hands when each alternative is selected.

A first cost of zero ($0) cash would be assigned to the defender and a first cost of $850

to the challenger(-$1 050 purchaseprice of the challengerand+$200in salvagevalue

from defender). We calculate thedifferencedue to first cost between the SK-30 and EL-40

to be:

Annualized first coStSK-30=$O(Aj P,10%,3) = $0

Annualiied first costEL-40=($1050 - 200)(Aj P,10%,3)=$342

AFCEL-40- AFCSK-30=$342 - $0=$342

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When both the remaining life of the defender and the useful life of the challenger are

the same, 3 years in this case, the analysis of the first cost yields an identical (and correct)

result. Both theopportunity costandcashflowperspectivesfor considering first cost of the

defender and challenger result in a difference of $342 between the two alternatives on an

annual cost basis.

Now see what happens when the remaining life of the defender is Q.otequal to the useful

life of the challenger.Consider the SK-30 and EL-40 word processors, but assume that the

lives have been changed as follows: '

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1'1

f

1;1'

Remaining life

SK-30

3 years Usefullife

EL-40

5 years

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