Problem 3C:

A Farm wants to develop a replacement policy for its 2-year-old tractor over the next 5 years. A tractor must be kept in service for at least 3 years, but must be disposed of after 5 years. The current purchase price of a tractor is $20,000 and increases by 10% a year. The salvage value of a 3-year-old tractor is $10,000 and decreases with age by 10% a year. The current annual operating cost of the tractor is $1000 but is expected to increase by 10% a year. At the end of year 5 (end of the planning horizon), the tractor is salvaged.

Determine the optimal replacement policy of the tractor over the next 5 years.