The one-year principle is a shortcut for replacement analysis that applies when an asset has small remaining capital costs and steadily rising O&M costs. Under those conditions, the asset’s economic life collapses to one year — its EAC is just the next year’s O&M cost — and the keep-or-replace decision reduces to a year-by-year comparison.
The setup is common for old paid-off assets:
- The original purchase price is a Sunk cost — ignore it.
- The current market value is small, so the capital-cost EAC is small.
- O&M cost is rising as the asset ages.
Under these conditions, is dominated by O&M, and the optimal hold is determined by the trade-off between this year’s O&M and the challenger’s EAC. Replacement happens when next year’s O&M would exceed the challenger’s EAC.
Formally, EAC_total ≈ EAC_O&M evaluated at :
Decision: if this number exceeds the challenger’s EAC, replace now. Otherwise, keep for one more year and re-ask the question next year.
Why “one year”? Because under the conditions above, the asset effectively has no economic life left — every year of holding is a separate decision. There’s no benefit to committing to “I’ll keep it for three more years” when each year’s keep-or-replace decision can be re-made based on actual conditions.
The principle is wider than its name suggests. It also applies (with the period adjusted) to assets that operate on weekly, monthly, or other natural cycles. The general form: when capital cost is small relative to operating cost, the economic life equals one operating period.
Pitfall. Don’t apply the one-year principle to assets whose capital cost is still significant. If the defender’s current market value is large, selling it now incurs a meaningful opportunity cost, and the capital-cost-amortisation term in the EAC matters. Use full EAC analysis in that case, not the one-year shortcut.
For the broader framework see Replacement decision and Equivalent annual cost. For the related cost concepts see Sunk cost and Opportunity cost.