The one-year principle is a shortcut for replacement analysis 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.
So is dominated by O&M, and the optimal hold comes down to the trade-off between this year’s O&M and the challenger’s EAC. Replace 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”? Under the conditions above the asset has no economic life left, so every year of holding is a separate decision. No benefit to committing to “I’ll keep it for three more years” when you can re-make the keep-or-replace call each year on actual conditions.
The principle is wider than its name suggests. With the period adjusted, it also applies to assets that run on weekly, monthly, or other natural cycles. General form: when capital cost is small relative to operating cost, the economic life equals one operating period.
Pitfall. Don’t apply this to assets whose capital cost is still large. If the defender’s current market value is high, selling it now incurs a real opportunity cost and the capital-cost-amortisation term in the EAC matters. Use full EAC analysis there, not the one-year shortcut.
For the full method see Replacement decision.