The Economic Life of Industrial Equipment Reconsidered
16 Pages Posted: 9 Oct 2005
Date Written: March 2002
The paper deals with two particular investment decisions: optimizing the investment date and opitmizing a single identical replacement. The objective is to maximize the net present value. For the common and convenient assumption of a flat term structure of inetrest rates, two results are known. Firstly, it is never optimal to delay an investment with a positive net present value. Secondly, the optimal economic life of the first machine is less than or equal to the optimal economic life of the second machine (general law of replacement). We demonstrate that both results seize to hold when not-flat term structures, and it is shown why the latter are nescessarily more complicated. In a broader perspective, the paper proves that the assumption of a flat term structure is not innocuous and the seemingly general well-known results only hold for a special case.
Keywords: general law of replacement, net present value, term structure of interest rates, investments
JEL Classification: D92, G31
Suggested Citation: Suggested Citation