How do actual cash value and replacement cost differ?

Actual cash value (ACV) and replacement cost are important concepts in insurance that represent different ways of valuing property. The distinction hinges largely on how depreciation is factored into the valuation.

Actual cash value is defined as the replacement cost of an asset minus depreciation. This means that when calculating ACV, the current worth of the item is considered, which drops over time as the item ages or wears out. Therefore, this valuation reflects the item’s current market value, rather than the cost to replace it with a new item.

On the other hand, replacement cost refers to the expense that would be incurred to replace the item with a new one of similar kind and quality, without accounting for depreciation. This means that replacement cost insurance would cover the full cost of buying a brand-new version of an item, regardless of the age or condition of the existing item that is being replaced.

This fundamental difference explains why the chosen answer is correct. Actual cash value takes depreciation into account, leading to a lower valuation than replacement cost, which represents the full, current market price of a new item.