Minggu 12 Chapter 13 Replacement Analysis Rev 7 Nov 2020

Note: These PowerPoints were developed to
support the US edition of the text. In some

cases, figure numbers, variables, and other
items may not correspond to the
international edition.
Copyright Oxford University Press 2014 1

Chapter 13
Replacement Analysis
2
Copyright Oxford University Press 2014
Chapter Outline
• Replacement Problem
• Replacement Analysis Decision Maps
• Minimum-Cost Life
• Marginal Cost of Keeping an Asset one more year
• Replacement Analysis Techniques
• Replacement Repeatability Assumptions
• After-tax Replacement Analysis
• Spreadsheet and Replacement Analysis
3
Learning Objectives
• Recognize and develop replacement problems

• Use the decision map to select the appropriate
replacement analysis technique to apply
• Calculate the minimum cost life of an asset
• Apply replacement analysis techniques correctly
• Perform replacement problems on an after-tax
basis
• Use spreadsheet in solving replacement
analysis problems
4
Issues
• Should we replace the current equipment
with the new one?
• Should we retain the current equipment for
another year and then replace it?
5
The Replacement Problem
• Obsolescence occurs when an asset’s technology

is surpassed by newer and/or different
technologies (PC)
• Depletion is the gradual loss of market value of an
asset as it is being consumed or exhausted (Oil
well, Timber)
• Deterioration is the general loss in value of an
asset due to aging process (Production machinery)
6
The Replacement Problem
• Planned replacements can be scheduled to minimize

the time and cost of disruptions.
• Variations of replacement problems, such as
abandonment, retirement, improvements of defender
or keeping defender as spare, can be considered as
potential new challenger.
• Since replacement problems usually are considered
with “fixed output”, only costs of defender and
challengers are analyzed.
• Due to the lives of the defender and challengers are
usually different, most calculations focus on annual
marginal costs or on EUAC.
7
Minimum Cost Life of a New Asset
• The minimum cost life of any new asset is the number of

years at which the EUAC of ownership is minimized.
• Because of increasing operating and maintenance
costs, the minimum cost life is often shorter than the
asset’s useful life.
• EUAC for each possible life, less than or equal to the
useful life, is determined. The number of years at
which the EUAC is minimum can then be identified.
• N (period) where the EUAC is minimum is called the
economic life
• Why?
8
• If assets are kept for only a few years, then

the EUAC is high because capital costs are
spread over only a few years.
• If assets are kept for too long, then the
EUAC is high because maintenance and
operating costs become large.
• The economic life strikes a balance that
minimizes the total EUAC.
9
Example 13-1
Year Maint. Operating O&M EUAC(O&M) CR EUAC(Total)
1 $0 $500 $500 $500 $8,100 $8,600
2 900 900 1,800 1,125 4,206 5,331
3 1,800 1,300 3,100 1,733 2,910 4,644
4 2,700 1,700 4,400 2,325 2,264 4,590*
5 3,600 2,100 5,700 2,900 1,878 4,779
6 4,500 2,500 7,000 3,459 1,622 5,082
7 5,400 2,900 8,300 4,002 1,441 5,442
8 6,300 3,300 9,600 4,528 1,305 5,833
9 7,200 3,700 10,900 5,038 1,201 6,239
10 8,100 4,100 12,200 5,533 1,118 6,650
11 9,000 4,500 13,500 6,011 1,051 7,062
12 9,900 4,900 14,800 6,474 995 7,470
13 10,800 5,300 16,100 6,922 949 7,871
14 11,700 5,700 17,400 7,355 910 8,265
15 12,600 6,100 18,700 7,773 876 8,649
10
Example 13-1
10000
8000
Total EUAC
6000
Cost
O&M
4000
2000 Capital Recovery
0
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Year
11
Decision Map
Defender Identify Alternatives Best Challenger
Available Defender Not Available

Marginal Cost Data?
Defender No Find EUAC

Marginal Cost Find lowest EUAC
over given life
Increasing? for Defender
Yes
Analysis Technique 2: Analysis Technique 3:
Analysis Technique 1: Defender’s lowest Defender’s EUAC
Defender’s next year EUAC  Challenger’s over its remaining life
marginal cost  EUAC at its minimum  Challenger’s EUAC
Challenger’s EUAC cost life at its min. cost life
12
13
Fundamental
• By looking at the replacement analysis map, we see
that the first step is to identify the alternatives.
• Again, in replacement analysis we are interested in
comparing the previously implemented asset (the
defender) against the best current available
challenger.
If the defender proves more economical, it will

be retained. If the challenger proves more
economical, it will be installed.
14
Defender’s Marginal Cost Data
• Are the Defender marginal cost data available?

• Are the Defender marginal cost increasing?
• The total marginal cost for any year can include:
• Capital Recovery Cost (loss in market value and
loss interest for the year)
• Yearly operating and maintenance costs
• Yearly taxes and insurance
• Any other expenses that occurs during that year
• The marginal cost is calculated as an equivalent end-
of-year cash flow
• Marginal costs, as opposed to an EUAC, are the
year-by-year costs of keeping an asset. Therefore, the
“period” of any yearly marginal cost of ownership is
always 1 year.
15
Example 13-2
Marginal Cost Calculation
Cost of Total
Market Capital Breakdown Marginal
Year Value Recovery O&M Risk Cost
1 $18,000 $10,750 $2,000 $5,000 $17,750
2 13,000 7,700 2,500 5,000 15,200
3 9,000 5,950 3,000 5,000 13,950
4 6,000 4,350 3,500 6,500 14,350
5 4,000 2,900 4,000 8,000 14,900
6 3,000 1,600 4,500 9,500 15,600
7 2,500 950 5,000 11,000 16,950
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 = 𝑀𝑀𝑀𝑀𝑁𝑁−1 (𝐴𝐴/𝑃𝑃, 15%, 1) – 𝑀𝑀𝑀𝑀𝑀𝑀(𝐴𝐴/𝐹𝐹, 15, 1)
= 𝑀𝑀𝑀𝑀𝑁𝑁−1 (1 + 15%) – 𝑀𝑀𝑀𝑀𝑀𝑀(1)
= (𝑀𝑀𝑀𝑀𝑁𝑁−1 – 𝑀𝑀𝑀𝑀𝑀𝑀) + 𝑀𝑀𝑀𝑀𝑁𝑁−1 (15%)
16
Alternative way to calculate
Capital Recovery
17
Example 13-3
Marginal Cost Calculation
Total
Market Capital Operating Marginal
Year Value Recovery Cost Cost
0 $15,000
1 14,000 $3,250 $10,000 $13,250
2 13,000 3,100 11,500 14,600
3 12,000 2,950 13,000 15,950
4 11,000 2,800 14,500 17,300
5 10,000 2,650 16,000 18,650
𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 = 𝑀𝑀𝑀𝑀𝑁𝑁−1 (𝐴𝐴/𝑃𝑃, 15%, 1) – 𝑀𝑀𝑀𝑀𝑀𝑀(𝐴𝐴/𝐹𝐹, 15, 1)

= 𝑀𝑀𝑀𝑀𝑁𝑁−1 (1 + 15%) – 𝑀𝑀𝑀𝑀𝑀𝑀(1)
= (𝑀𝑀𝑀𝑀𝑁𝑁−1 – 𝑀𝑀𝑀𝑀𝑀𝑀) + 𝑀𝑀𝑀𝑀𝑁𝑁−1 (15%)
18
Replacement Analysis Technique 1:
Defender Marginal Cost Increasing
• Maintain the Defender as long as the
marginal cost of ownership for one more
year is less than the Challenger’s minimum
EUAC.
• When the Defender’s marginal cost
becomes greater than the Challenger’s
minimum EUAC, then replace the Defender
with the Challenger.
19
Example 13-4
Replacement Analysis Technique 1
Challenger Challenger Defender
Year Marginal Cost EUAC Year Marginal Cost
1 $17,750 $17,750.00 1 $13,250
2 15,200 16,563.95 2 14,600
3 13,950 15,811.20 3 15,950
4 14,350 15,518.57 4 17,300
5 14,900 15,426.83* 5 18,650
6 15,600 15,446.61
7 16,950 15,582.46
𝑁𝑁
𝐸𝐸𝐸𝐸𝐸𝐸𝐸𝐸 = � 𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀𝑀 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝑗𝑗 𝑃𝑃⁄𝐹𝐹 , 15%, 𝑗𝑗 (𝐴𝐴⁄𝑃𝑃 , 15%, 𝑁𝑁)
𝑗𝑗=1
KEEP THE DEFENDER FOR 2 YEARS AND THEN REPLACE IT
20
Calculating EUAC from MC
21
Replacement Repeatability
Assumption
• Currently available best Challenger will
continue to be available in subsequent years
and will be unchanged in its economic costs.
When the Defender is ultimately replaced, it
will be replaced with this Challenger.
• The period of needed services of the asset
is indefinitely long.
22
Defender Marginal Cost Not Increasing
• Calculate the Defender’s minimum EUAC.
• If the Defender’s minimum EUAC exceeds the
Challenger’s minimum EUAC, then replace
immediately.
• If the Defender’s minimum EUAC is lower than the
Challenger’s minimum EUAC, then the Defender
will be kept at least the minimum cost life.
• After the minimum cost life, then replace when the
Defender’s increasing marginal cost exceeds the
Challenger’s minimum EUAC.
23
Example 13-5
Challenger Defender
Marginal Challenger Marginal Defender
Year Cost EUAC Year Cost EUAC
1 $17,750 $17,750.00 1 $16,000 $16,000.00
2 15,200 16,563.95 2 14,000 $15,069.77
3 13,950 15,811.20 3 13,500 $14,617.71*
4 14,350 15,518.57 4 15,300 $14,754.35
5 14,900 15,426.83* 5 17,500 $15,161.57
6 15,600 15,446.61
7 16,950 15,582.46
𝑁𝑁
𝑗𝑗=1
KEEP THE DEFENDER AT LEAST 3 YEARS, YEAR 4 & 5 USE TECHNIQUE 1
Year 4 keep the defender because its marginal cost is less than Challenger EUAC
Replace the defender at the end of year 4
24
Example 13-6
Finding Minimum Cost Life
Market Capital Marginal
Year Value Recovery O&M Cost EUAC
0 $5,000
1 4,000 $1,500 $0 $1500 $1,500.00
2 3,500 900 100 1000 1,261.90
3 3,000 850 200 1050 1,197.89
4 2,500 800 300 1100 1,176.79
5 2,000 750 400 1150 1,172.41
6 2,000 200 500 700 1,111.18
7 2,000 200 600 800 1,078.38
8 2,000 200 700 900 1,062.78
9 2,000 200 800 1000 1,058.16*
10 2,000 200 900 1100 1,060.78
11 2,000 200 1,000 1200 1,068.29
25
13.6 Calculating minimum
EUAC
26
Example 13-7
Challenger Defender Defender
Year EUAC Overhaul Defender Marginal Defender
1 $8,600 Year Cost O&M Cost EUAC
2 5,331 0 $4,000
3 4,644 1 $1,800 $6,120 $6,120.00
4 4,590* 2 1,800 1,800 4,043.08
5 4,779 3 2,800 2,800 3,660.17*
4 3,800 3,800 3,691.20
5 4,800 4,800 3,880.20
𝑁𝑁
𝑗𝑗=1
Overhaul the defender, keep for 3 years and then use Technique 1
27
Defender Marginal Cost Not Available
• Calculate the Defender’s EUAC over its stated
useful life.
• If the Defender’s EUAC exceeds the Challenger’s
minimum EUAC, then replace immediately.
• If the Defender’s EUAC is lower than the
Challenger’s minimum EUAC, then the Defender
will be kept.
28
Defining First Costs of
Defender and Challenger
• Present market value, not the trade-in value,
should be assigned as the first cost of the
Defender.
• The first cost of the Challenger should include the
purchase price, sales tax, installation cost, and
other items that occur initially on a one-time basis
if the Challenger is selected.
• The Defender’s potential market (or salvage) value
should not be subtracted from the Challenger’s
first cost.
29
Example 13-9
Defining Defender First Cost
Defender: SK-30, purchased 2 years ago for $1600, was
depreciated with SL using 4-year life and 0 salvage.
Challenger: EL-40, $1200 with a trade-in allowance of $350
for the SK-30; $1050 without a trade-in.
Current price for new SK-30 is $995.
Defender: SK-30,
• Original cost: $1600 (Basis for SL depreciation)
• Present cost: $995 (Irrelevant)
• Book value: $800 (Useful in determining depreciation
recapture or loss)
• Trade-in value: $350 (Irrelevant)
• Market value: $200 (First cost assigned to Defender)
30
Repeatability Assumption
Not Acceptable
Circumstances that Repeatability Assumption may
not apply:
• When there is a specific study period instead of an
indefinite need for the asset
• When future Challengers are not assumed to be
identical to the current best Challenger
31
A Closer Look at Future Challengers
• It seems likely that future Present

Challenger
challengers will be better
than the present Challenger Uniform Decline
EUAC at Economic Life

• The prospect of better
future challengers may
make it more desirable to
retain the Defender and to Rapid Improvements
reject the present In Technology
Challenger
• Selecting the current best
Challenger could be risky if
1) high cost and/or 2) long
0 1 2 3 4
economic life Year
32
After-Tax Replacement Analysis
• Ordinary taxes
• Gains and losses due to asset disposal
33
Example 13-10
Marginal Costs on After-Tax Basis
Recaptured After-tax
Market Book Depr. or Market
Year Value Value Loss Tax Value
0 $25,000 $25,000 $25,000
1 18,000 20,000 -$2,000 -$800 18,800
2 13,000 15,000 -2,000 -800 13,800
3 9,000 10,000 -1,000 -400 9,400
4 6,000 5,000 1,000 400 5,600
5 4,000 4,000 1,600 2,400
6 3,000 3,000 1,200 1,800
7 2,500 2,500 1,000 1,500
34
Example 13-10
Marginal Costs on After-Tax Basis
After-tax After-tax
Market Capital O&M+ Taxable Marginal
Year Value Recovery Ins. Income Tax Cost
0 $25,000
1 18,800 $8,700 $7,000 -$12,000 -$4,800 $10,900
2 13,800 6,880 7,500 -12,500 -5,000 9,380
3 9,400 5,780 8,000 -13,000 -5,200 8,580
4 5,600 4,740 10,000 -15,000 -6,000 8,740
5 2,400 3,760 12,000 -17,000 -6,800 8,960
6 1,800 840 14,000 -14,000 -5,600 9,240
7 1,500 480 16,000 -16,000 -6,400 10,080
35
Example 13-11
After-tax Minimum Cost Life
Recaptured After-tax
Market MACRS Book Depr. or Market
Year Value Depr. Value Loss Tax Value
0 $100,000 $100,000 $100,000
1 50,000 $14,290 85,710 -$35,710 -$14,284 64,284
2 45,000 24,490 61,220 -16,220 -6,488 51,488
3 40,000 17,490 43,730 -3,730 -1,492 41,492
4 35,000 12,490 31,240 3,760 1,504 33,496
5 30,000 8,930 22,310 7,690 3,076 26,924
6 25,000 8,920 13,390 11,610 4,644 20,356
7 20,000 8,930 4,460 15,540 6,216 13,784
8 15,000 4,460 0 15,000 6,000 9,000
9 10,000 0 10,000 4,000 6,000
10 5,000 0 5,000 2,000 3,000
36
Example 13-11
After-tax Minimum Cost Life
After-tax After-tax
Market Capital Taxable Marginal
Yr. Value Recovery O&M Income Tax Cost EUAC
0 $100,000
1 64,284 $41,716 $10,000 -$24,290 -$9,716 $42,000 $42000
2 51,488 16,653 14,000 -38,490 -15,396 15,257 29018
3 41,492 13,085 18,000 -35,490 -14,196 16,889 25208
4 33,496 10,486 22,000 -34,490 -13,796 18,690 23718
5 26,924 8,582 26,000 -34,930 -13,972 20,610 23167
6 20,356 8,183 30,000 -38,920 -15,568 22,615 23088*
7 13,784 7,793 34,000 -42,930 -17,172 24,621 23270
8 9,000 5,611 38,000 -42,460 -16,984 26,627 23610
9 6,000 3,540 42,000 -42,000 -16,800 28,740 24056
10 3,000 3,360 46,000 -46,000 -18,400 30,960 24580
37

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Minggu 12 Chapter 13 Replacement Analysis Rev 7 Nov 2020

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Note: These PowerPoints were developed to

support the US edition of the text. In some

Copyright Oxford University Press 2014 1

• Recognize and develop replacement problems

• Obsolescence occurs when an asset’s technology

• Planned replacements can be scheduled to minimize

• The minimum cost life of any new asset is the number of

• If assets are kept for only a few years, then

2000 Capital Recovery

Available Defender Not Available

Defender No Find EUAC

If the defender proves more economical, it will

• Are the Defender marginal cost data available?

𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅𝑅 𝐶𝐶𝐶𝐶𝐶𝐶𝐶𝐶 = 𝑀𝑀𝑀𝑀𝑁𝑁−1 (𝐴𝐴/𝑃𝑃, 15%, 1) – 𝑀𝑀𝑀𝑀𝑀𝑀(𝐴𝐴/𝐹𝐹, 15, 1)

• It seems likely that future Present

EUAC at Economic Life

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