defender is selected to continue in the service. In other words, if the defender is selected, the opportunity to obtain its current market value is forgone. Sometimes the additional cost required to upgrade the defender to make it competitive for comparison with the new alternatives is added to its market value to establish the total investment for the defender. Along with the market value, there will be revised estimates for annual operating and maintenance cost, salvage value and remaining service life of the defender, which are expected to be different from the original values those were estimated at the time of acquiring the asset. The past estimates of initial cost, annual operating and maintenance cost, salvage value and useful life of defender are not relevant in the replacement analysis and are thus neglected. The past estimates also incorporate a sunk cost which is considered irrelevant in replacement analysis. Sunk cost occurs when the book value (as determined using depreciation method) of an asset is greater than its current market value, when the asset (i.e. defender) is considered for replacement. In other words it represents the amount of past capital investment which can not be recovered for the existing asset under consideration for replacement. Sunk cost may occur due to incorrect estimates of different cost components and factors related productivity of the defender, those were made at the time of original estimates in the past with uncertain future conditions. Since sunk cost represents a loss in capital investment of the asset, the income tax calculations can be done accordingly by considering this capital loss. In replacement analysis the incorrect past estimates and decisions should not be considered and only the cash flows (both present and future) applicable to replacement analysis should be included in the economic analysis. For replacement analysis, it is important know about different lives of an asset, as this will assist in making the appropriate replacement decision. The different lives are physical life, economic life and useful life. Physical life of an asset is defined as the time period that is elapsed between initial purchase (i.e. original acquisition) and final disposal or abandonment of the asset. Economic life is defined as the time period that minimizes the total cost (i.e. ownership cost plus operating cost) of an asset. It is the time period that results in minimum equivalent uniform annual worth of the total cost of the asset. Useful life is defined as the time period during which the asset is productively used to generate profit. In replacement analysis the defender and challenger is compared over a study period. Generally the remaining life of the defender is less than or equal to the estimated life of the challenger. When the estimated lives of the defender and challenger are not equal, the duration of the study period has to be appropriately selected for the replacement analysis. When the estimated lives of defender and challenger are equal, annual worth method or present worth method may be used for comparison between defender and the challengers (new alternatives).

In the following example, replacement analysis involving equal lives of defender and challenger is discussed.