The economic life of an asset is the holding period that minimises its total equivalent annual cost (EAC). Hold the asset longer or shorter and the EAC is higher. So it’s the “right time to replace” the asset.
What makes economic life well-defined is a trade-off between two cost streams that move in opposite directions as the asset ages.
Capital cost EAC: amortise the purchase-minus-salvage difference over the holding period . This per-year number is high if you hold the asset only briefly (you haven’t spread the capital cost over enough years) and low if you hold it a long time (the capital is spread thin). Capital cost EAC falls as rises.
Operating-and-maintenance EAC: operating cost is low when the asset is new and rises with age, since bearings wear, parts break, efficiency drops. O&M EAC rises with .
Total EAC is the sum. As rises, capital EAC drops and O&M EAC rises, and the sum has a U-shape with a minimum somewhere in the middle. That minimum is the economic life.
Industrial example: capital EAC might be $15,000/year at , dropping to $2,000/year at . O&M EAC might be $500/year at , rising to $10,000/year at . The two sums hit a minimum around at maybe $8,000/year total. So this asset’s economic life is 7 years.
Three “life” concepts to keep separate:
- Physical life — how long the asset can run before falling apart. Set by physics, not economics.
- Service life — how long it’s actually in service. Equal to or less than physical life.
- Economic life — the optimal hold from a cost perspective. Usually shorter than physical life.
Keeping an asset past its economic life costs you: the rising O&M more than offsets the capital “discount” of having already owned it for a while. That’s the argument for replacing aging assets even when they still work.
When the one-year principle applies (capital small, O&M rising steadily), the economic life collapses to one year. The common case is an old paid-off asset whose only remaining cost is operating expense, the “should we keep it one more year?” framing.
For the EAC machinery see Equivalent annual cost and Capital recovery factor.