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Replacement & Assessment

Engineer ing
INE 428

Lec 2

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Time Value of Money Relation

(F / P,i,N) F = P (1+i)N

N
F?

P Given

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Time Value of Money Relation
(P / F,i,N) Given

P = F / (1+i)N
N
F

P?
F 1 N
P = = F
(1+i)N 1+i
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Time Value of Money Relation

(A / F,i,N) Given

A ? F
N

i
A= F
(1+i)N - 1

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Time Value of Money Relation

(F / A,i,N)
A Given F?
N
(1+i)N - 1
F=A
i

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Time Value of Money Relation

(P / A,i,N)
A Given

N
P? (1+i)N - 1
P=A
i (1+i)N

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Time Value of Money Relation

(A / P,i,N)
A ??

N
PGiven (1+i) N
i
A= P
(1+i)N - 1

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Time Value of Money Relation
G Given
(A / G,i,N) (N-1)G
3G
N 2G
0 G

A ??
(1+i)N - i N - 1
A= G i(1+i)N - i

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Time Value of Money Relation
G Given
(P / G,i,N) 3G
(N-1)G
N 2G
G
0

P ??

(1+i)N - i N - 1
P= G i2 (1+i)N
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2- Equivalent Annual Cost
Equivalent Annual Cost :EAC
EAC=P(A/P,i,n) - S(A/F,i,n) S
= (P-S) (A/P,i,n)+Si

Prove: n

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2- Equivalent Annual Cost
i(1 + i) n i
(A/P, i, n) = (A/F, i, n) =
(1 + i) n 1 (1 + i) n 1
i(1 + i) n i(1 + i) n i[(1 + i) n 1]
(A/P, i, n) - i = i = =
(1 + i) 1
n
(1 + i) 1
n

i(1 + i) i (1 + i) + i
n n
i
= = ( A / F , i, n)
(1 + i) 1
n
(1 + i) 1
n

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2- Equivalent Annual Cost
(A/P,i,n)-i= (A/F,i,n)
Then
EAC = P(A/P,i,n) - S(A/F,i,n)=
EAC = P(A/P,i,n) S[(A/P,i,n)-i]
EAC = (A/P,i,n)(P-S) + Si

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Example 1
The price of the asset is 60,000 with
20,000 salvage value in 4 years and the
interest rate is 10%, Calculate the EAC
Solution
EAC= P(A/P,i,n) - S(A/F,i,n)
= 60,000(0.31547)-20,000(0.21547)
=$14,619
By using the equation:
EAC= (P-S)(A/P,I,n)+Si
=(60,000-20,000)(0.31547)+20,000(0.1)
= $14,619
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Example 2
A citys data processing manager is considering replacing the
computer that is being used for utility billing. Known and
estimated cost relating to the current system are

Year Trade-in Maintenance cost, Operating cost, $


value, $ $
0 12,000 -- --
1 8,000 5,000 28,000
2 3,000 6,000 32,500
Calculate the equivalent annual costs over the 2-year period?

With a MARR of 10%,


Minimum Attractive Rate of Return
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Solution 8,000 3000
0 1
2
5000
12000 6000
28000 32500
EAC= ($12,000 -3,000) (A/P, 10%, 2) +$3,000(0.1)
+[$5,000+$28,000)(P/F,10%,1)+(6,000+32,500)(P/F,
10%,2)](A/P,10%,2)

= 9000(0.57619) +300+
[33000(0.90909) +38500(0.82645)]
(0.57619)=41,105

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Solution
The annual cost for the first year is calculated on
the assumption that 12,000 is the first cost of the
computer and 8000 is the salvage value after the
first year
8,000 3000
0 1
2
5000
12000 6000
28000
AC year 1
=12,000(A/P, 10%, 1)- 8,000+33,000=$38,200

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Solution
Similarly,
AC for 2 years
= ($12,000 -3,000) (A/P, 10%, 2) +$3,000(0.1)
+[$5,000+$28,000)(P/F,10%,1)+(6,000+32,500)(P/F,
10%,2)](A/P,10%,2) =$ 41,105

3000
0 1
2
5000
12000 6000
28000
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Solution
Recommendation is to delay replacement
until the start of the second year
EAC=41,105

AC year 1= $38,200

AC year 2= $ 41,105
equivalent annual cost of the defender tells
us to go with the new system since it has
a smaller EAC value
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Example 3
consider the choice between a defender that has a current
market value of $5000 and a challenger that can be
purchased for $7500. Both have a service life of 3 years with
no salvage value expected at the end of that time. Their
operating costs are shown as

Year Defender D Challenger C Difference

0 5,000 7,500 -2,500


1 1,700 500 1,200
2 2,000 1,100 900
3 2,500 1,300 1200

MARR=12%
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Solution
EAC (D) =[$5,000+$1700(P/F, 12%, 1) +
$2000(P/F, 12%, 2) +2500(P/F, 12%, 3)] (A/P,
12%, 3) =$4119
EAC (C) =[$75,000+$500(P/F, 12%, 1) +
$1100(P/F, 12%, 2) +1300(P/F, 12%, 3)] (A/P, 12%, 3)
=$4059
which indicates that it should replace the defender

EAC=[-2,500+1,200(P/F, 12%, 1) +900(P/F, 12%, 2)


+1,200(P/F, 12%, 3)] (A/P, 12%, 3)] =$60
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Example 4
An asset was purchased 5 years ago for $52,000. It was
expected to have an economic life of 8 years, at which its
salvage value would be 4,000. If the function that the
asset was serving is no longer needed, for what price
must it be sold now to recover the invested capital when
i=12%.

life years =8 must it be sold


S.V=4,000 now
4,000
when i=12%.

P=? N=8
$52,000
N=5
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Solution
EAC= (P-S) (A/P, 0.12, 8) +S (0.12)
= (52,000-4,000) (0.20130) +4,000(0.12)
=48,000(0.2013) +480 =$10,142.4

The un-recovered capital at the end of fifth year


is the present worth of the last 3 years

Selling price (year 5) =


$10,142.4 (P/A, 0.12, 3) +4,000(P/F, 0.12, 3)
= $27,208

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