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Replacement Analysis

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Engineer ing

INE 428

Lec 3

1

3- Defender And

Challengers With Unequal

Lives

Example 1

An existing machine is worth $2,500 today and will lose

$1,000 in value by next year plus $500 per year therefore.

Its $8,000 operating cost for this year is predicted to

increase by $1000 annually, owing to deterioration. It will be

retired in 4-years, when its salvage value will be zero.

same function as the existing machine can be purchased for

$16,000 and is expected to have relatively constant annual

operating costs of $6,000 to the end of its 7-year economic life,

at which time the salvage value will be $1,500. No major

improvements are expected in the designs for machines of this

type within 7 years. If the minimum attractive rate of return is

12 %. Should the existing machine be replaced? If so, when?

3

Data

An existing machine (Defender) is worth $2,500 today

will lose $1,000 in value by next year plus $500 per year,

and life cycle = 4 year , salvage value = 0

minimum attractive rate of return is 12 %.

4

Solution

Defender Challenger

$1,500

7 years

0 0 1 2 3 4 5 6 7

1 2 3 4

A=$8,000

$2500 A=$ 6000

G=$1000

$16,000

5

Solution

For challenger

EAC=$6,000+(P-S)(A/P,12%,7)+Si

=6,000 + (16,000-1,500) (0.21912) +1500(0.12)

=$9,357

One-year cost of defender:

OC= $8,000

Capital recovery is (P-S)(A/P,12%,1)+Si=

=(2500-1500)1.12+1500(0.12) =1300

EAC def = $8000+$1300=$9,300

the defender has a lower cost for the next

year $9,300< $9,357

6

Solution

the defender has a lower cost for the next

year $9,300< $9,357

Operating costs=$8,000+$1,000=$9,000

year 2:

=$680

7

Solution

Two years cost of defender

EAC=(2500- 1000)(A/P,12%,2)+1000(0.12)+

[(8000*(P/F,12%,1)+9000*(P/F,12%,2)](A/P,12%,2)

EAC=1500)(0.5917)+1000(0.12)+

[(8000*(0.8929)+9000*(0.7972)](0.5917) =9479.5

the end of the first year

8

Example 2

The purchase price truck is $25,000, and the

anticipated schedule of future operating cost and

salvage value is given as

Cost Year

1 2 3 4 5 6

Operating cost 6,100 6,800 7,800 9,300 11,400 14,600

Resale value 15,000 12,000 9,300 7,100 5,400 4,300

9

Solution

1. If no interest

Capital C Cumulative Total C Average total costs/year

Year Operating C

2 13,000 12,900 25,900 12,950

3 15,700 20,700 36,400 12,133

4 17,900 30,000 47,900 11,975

5 19,600 41,400 61,000 12,200

6 20,700 56,000 76,700 12,783

10

Solution

2. If interest 10%

EAC=capital recovery + equivalent annual operating cost

= (P-S) (A/P,i,N)+ Si + FV(operating costs for N years)*(A/F,i,N)

15,000

12,000

9,300

7,100 5,400

4,300

0 1 2 3 4 5 6

6,100

6,800

7,800

9,300

11,400

25,000 14,600

EAC (N=1) = (25,000-15,000)(A/P,10%,1) +15,000(0.1)

+6100(A/F, 10, 1) = 18,600

11

15,000

Solution 12,000

9,300

7,100 5,400

4,300

25,000 0 1 2 3 4 5 6

6,100

6,800 7,800

9,300

11,400

14,600

EAC (N=2) = (25,000-12,000) (A/P, 10%,2)+12,000(0.1)

+ [6100(F/P, 10, 1) +6800] (A/F, 10, 2) =13,000(0.57619)

+1200+[6100(1.1)+6800](0.47619)=15,123

EAC (N=3) = (25,000-9,300) (A/P,10%,3)+9,300(0.1) +[6100

(F/P,10, 2)+ 6800(F/P, 10, 1) +7800](A/F, 10, 3)=15,700

(0.40211) +930+ [6100(1.21) +6800(1.1)+7800] (0.30211)

=14,090

EAC (N=4) =13,732

EAC (N=5) =13,745

EAC (N=6) =14.068 12

Solution

Comparison (EAC, 10%) And EAC at (0%)

years (10%) (0%)

1 18,600 16,100

2 15,124 12,950

3 14,090 12,133

4 13,732 11,975

5 13,745 12,200

6 14,068 12,783

n=4

13

Cost

Economic Life for Cyclic Replacements

maintenance costs

Capital costs

Age (year)

N

Economic life

14

Economic Life for Cyclic Replacements

Economic life is the period of time over which a

prudent owner will retain an existing facility to

minimize costs.

asset can no longer be repaired or refurbished so

that it can perform a useful function.

asset cannot perform its intended function without a

major overhaul. Such an overhaul is an investment

for which a new economic life has to be determined.

15

Optimum Replacement Interval

P m

ATC = + O + (n 1)

n 2

Where P = initial cost of the asset

O = annual operating costs for the first year

m = the amount by which maintenance costs

increase each year

16

Optimum Replacement Interval

ATC P m

= + =0

n n 2

2

2P

n=

m

j =k

AWK = -P(A/P, i, k) + SVK (A/F, i, k) - [ AOC j ( P / F , i, j )]( A / P, i, K )

j =1

17

Example 3

Machine A costs $80,000 Annual operating

costs are $2000 for the first year, and they

increase by $15,000 every year. Determine

the age at which to replace the machine

assuming that it has no resale value.

What will be the average yearly cost of

operating and owning the machine, if the

optimal replacement policy is followed?

18

Solution

1. If no interest

Using the table

The Capital O&M Cumulative Total Average

end of cost Cost O&M cost cost

year 1000$ 1000$

1 80 2 2 82 82.00

2 80 17 19 99 49.50

3 80 32 51 131 43.67

4 80 47 98 178 44.50

5 80 62 160 240 48.00

replaced at the end of three years.

19

Solution

using the equation

2P

n =

m

Where P= $ 80,000, m= $ 15,000

2 * 80,000

n= = 3.26

15,000

replace M/C at the end of three years

Also the previous table can be calculated using

this equation

P m

ATC = + O + (n 1)

n 2 20

Solution

Using the equation

ATC1= (80/1) + 2+ (0)*(15/2)=$ 82,000

ATC2= (80/2) + 2+ (1)*(15/2)=$ 49,500

ATC3= (80/3) + 2+ (2)*(15/2)=$ 43,666

ATC4= (80/4) + 2+ (3)*(15/2)=$ 44,500

ATC5= (80/5) + 2+ (4)*(15/2)=$ 48,000

ATC6= (80/6) + 2+ (5)*(15/2)=$ 52,833

Replace M/C at the end of three years

2. If interest 10% Report

21

Example 4

An inexpensive, low-volume office coping machine was

purchased 2 years ago for $1200. At the time of purchase

it was believed that the machines would have an

economic life of 5 years and salvage value of $100

operating costs over the first 2 years for material, labor,

and maintenance have average $4200 annual and are

expected to continue at the same level. Some type of

copier will be needed for the next several years. The

same company that manufactured the presently used

copying machine has a new model that cost of $1500 but

will perform the current workload with operating costs of

$3500 per year. The company is offering $500 for the old

model as a trade-in on the new machine. The expected

salvage value for the new model is $400 at the end of 5

years.

22

Example 4

Another company has a different type of copier that is

available only on a lease basis. The company claims

that leasing its copier at $1000 per year will reduce the

operating expense for the present amount of work to

$2750. Since this company does not accept trade-ins,

the machine now in use would have to be sold on the

open market, where it is expected to bring only $300.

If the minimum accepted rate of return is 10% before

taxes, should the defending copier be replaced by one of

the challengers?

23

Solution $300 $100

Defender 1 3 4 5

$1200

$4200

Operating costs are $4200;

capital recovery is

=(P-S)(A/P, 10%, 3)+S (0.1) = ($300-$100)

(0.40211) +$100(0.1) =$90

EAC (def.) =$4200+$90 = $4290

24

Solution

From the same company

500-300

400

1500

OC=3500

OC = $3500;

Capital recovery is

=(P-S)(A/P, 10%, 5)+S (0.1)= [(1500-200)-400]

(0.2638) +400(0.1) =$227

EAC (chal/new) =3500+277=$3777

25

Solution

Another company Offer:

Equivalent annual cost of the leased challenger:

Operating costs are $2750;

annual lease contract is $1000:

EAC (chal/lease) =2750+1000 = $3750

26

Solution

Defender

Equivalent annual cost of defender when

P= trade-in value=$500

OC= $4200.

Capital recovery is

=(P-S)(A/P, 10%, 3)+S (0.1)

=(500-100)(0.40211)+100(0.1) = $171

EAC (def) =4200+171= $4371

500 100

$4200

27

Solution

From the same company 400

3500

1500

OC= $3500.

Capital recovery is

=(P-S)(A/P, 10%, 5)+S (0.1)

=(1500 - 400)(0.2638)+400(0.1)=$330

EAC(chal/ven)=3500+330= $3830

28

Solution

Another company Offer:

Equivalent annual cost of the leased challenger:

Operating costs are $2750;

annual lease contract is $1000:

EAC (chal/lease) =2750+1000 = $3750

29

Example 5

A company owns several moving vans which are

deteriorating faster than expected. The vans were

all purchased 2 years ago for $60,000 each. The

company currently plans to keep the vans for 10

more year. Fair market value for a 2-year old van

is $42,000 and for 12-year-old van is $8,000.

Annual fuel, maintenance, tax, etc. costs, that is

AOC, is $12,000 per year. The replacement

option is to lease on a yearly basis. The annual

lease cost is $9,000 (year-end-payment) with

annual operating cost of $14,000. Should the

company lease its van if the MARR is 12%?

30

Solution

Data

Defender D Challenger C

P=$42,000 Least cost=$9,000 per year

AOC=$12,000 AOC=$14,000

Sv=$8,000 Sv=0

n=10years n=10years

31

Solution

The annual worth of Defender is

AWD=-P(A/P,i,n)+SV(A/F,i,n)-AOC

=42,000 (0.17698) +8000(0.05698)-12,000

=-$18,977

AWC=-9,000 -14,000= -$23,000

since AWD is numerically larger than AWC.

32

33

Quiz 1

1. Define the Replacement and Why

Replacement Studies are Performed?

scrap value is $100 at any time. The

maintenance costs found from experience

are as follows:

year 1 2 3 4 5 6 7 8

Maintenance

100 250 400 600 900 1200 1600 2000

cost $

34

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