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ENGINEERING ECONOMY Sixth Edition Blank and Tarquin

CHAPTER 11 Replacement and Retention Decisions Gra Hill w
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Chapter 11 Learning Objectives
1. 2. 3. 4.
Basics of Replacement Study; Economic Service Life; Performing a Replacement Study; Additional Considerations in a Replacement Study; 5. Replacement Study over a Specified Study Period; 6. Chapter Summary

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CHAPTER 11 Section 11.1 Basics of Replacement Study

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11.1 Why Replace Assets
Reduced Performance:
  

Wear and Tear; Decreasing reliability and Productivity; Increasing operating and maintenance costs. New production needs, accuracy, speed, etc. Current assets may be less productive; Not state of the art – meet competition.

Altered Requirements:

Obsolescence:
 

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11.1 Terminology
Defender Asset:

Current installed asset; The potential replacement or “challenging” asset; Under consideration to replace the defender asset. Constitute mutually exclusive alternatives; Select one and reject the other.

Challenger Asset:
 

Together, the Defender and Challenger:
 

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11.1 Annual Worth Values
Analysis Approach for Replacement:
 

Annual Worth Approach; EUAC – since costs tend to dominate the study (-) cash flows; Salvage values – if any – are also part of the analysis (+) value.
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11.1 Economic Service Life
Economic Service Life (ESL)

Number of years for an alternative for which the AW or EUAC is Minimum; Implies that a period by period analysis is performed; Computing the AW for 1 year; then 2 years; … until a minimum cost time period is found; Performed manually or by spreadsheet.

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11.1 Investment ConcernsDefender
For a replacement analysis two investment costs are critical:
1.

The proper investment cost to apply to keeping the defender in service; The proper investment cost to apply to any challenger asset that might replace the current defender asset.
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11.1 Investment ConcernsDefender
While it may seem strange to charge an investment cost for keeping one’s own asset (the defender) this is what must occur. Keeping the defender is not free! Why?

Because the firm is giving up the opportunity to receive a possible cash flow from selling the current defender!

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11.1 Investment Concerns
One must assign an investment cost to KEEPING the defender asset! The appropriate investment cost to assign to the defender asset is:

The current fair market value of the defender at the time the replacement decision is being examined.
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11.1 Defender First Cost
Defender First Cost:

Initial investment in the defender asset back in time; This investment (cost) is considered “sunk” for analysis purposes; A past cost that cannot be changed or altered; The issue of the relevance of the investment cost in the analysis will be addressed soon.
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11.1 Challenger First Cost
This is the total investment (Pchallenger ) required in a new (challenger) asset that will possibly replace the current defender. In a replacement study this investment is know with a fair amount of certainty. What IF a trade in value is offered for the defender to apply to the challenger?

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11.1 Trade In Concerns
Often a trade in value is offered by a vendor to take in the defender with a credit on the purchase towards the challenger. Be careful how this is handled! Points to focus upon….

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11.1 Basic Principles
The past investment in the defender is “sunk” and not totally relevant to the analysis. Only the Fair Market Value (FMV) of the defender is relevant.

FMV of the defender is the net economic worth of the current defender; Sale or disposal price less any costs associated with removing the defender.

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11.1 Basic Principles – Important Question At times, a “high” trade-in value may be offered for the defender compared to its current fair market value. If this is the case:

What should be the investment cost in the challenger for a replacement study analysis if a trade-in value is offered?

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11.1 Trade-In Issues
If a trade-in is offered what should be the proper investment cost in the challenger?

Let PC = the cash sale price of the challenger with no trade-in; Let TIV = the trade-in value for the challenger as offered by the vendor (take in the defender); Let MVD = the Fair Market Value of the current defender;
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11.1 Trade-In Issues
For a Trade-In, the correct investment cost to assign to the challenger is:

Investment in the Challenger:

PC – (TIV – MVD)

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11.1 Trade-In Issues
Investment in the challenger

PC – (TIV – MVD)
Cash Price for the challenger less:
(Trade-in Value – Market Value of the Defender)

This represents the true investment in the challenger to the firm!
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11.1 Trade-In Issues
Investment in the challenger

PC – (TIV – MVD)
The Cash price for The challenger with No trade-in

The Opportunity Cost Given up by not Selling the Defender outright!

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11.1 Trade-In Issues - Example
Bought a system 3 years ago for $120,000. (Defender); A fair market value of the current defender is $70,000 right now; A challenger can be purchased for cash for $100,000 now! The vendor selling the challenger offers a trade-in of $80,000 on the current defender.
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11.1 Trade-In Issues - Example
What should be the proper investment cost for the challenger to the firm if the defender is traded?
   

PC = $100,000; TIV = $80,000 FMVD = $70,000 InvestmentChallengernow = $100,000 – ($80,000 - $70,000) = $90,000.

This represents the “true” investment in the challenger with the trade.
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11.1 Other Issues…
Investment in the challenger asset must include:
   

Actual cash price for purchase; Transportation costs; Installing/make-ready for use costs; Other one-time costs at time t = 0 associated with placing the challenger in-service.

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11.1 Warning! What Not to Do!
At times a decision maker might do the following:

Take the investment cost in the challenger; Then add the remaining book value of the defender to that investment; This is wrong! Overly penalizes the challenger with a sunk cost associated with the defender asset! Do not do this!
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 

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11.1 Sunk Costs
A “sunk” cost is any cost that has occurred in the past and cannot be changed or altered by a current decision. The past investment in any defender or its remaining book value is not relevant! Unless, an after-tax replacement analysis is being conducted!
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11.1 Allocating Costs
Allocate only those costs associated with:

The Defender (opportunity cost of not disposing – giving up a salvage value if kept.) Those costs associated with obtaining the challenger – do not penalize the challenger with costs from the defender!

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11.1 The Suggested Viewpoint
It is customary to take the following philosophical approach: This is termed:
 

The Outsider’s view or, The Consultant’s view.

One assumes that the analyst is an outsider to the firm and owns neither the defender or the challenger!
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11.1 Outsider’s or Consultant’s View
One assumes that you own neither of the assets in question; The service provided by the defender can be “purchased” with an investment of the firm’s money equal to the current fair market value of the defender.
 

Buy your own asset! Hard to comprehend? Perhaps…but this is an objective approach to costing the defender!

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11.1 Costing the Defender
The consultant’s view assumes:

If the defender is retained in service, the firm is giving up (forgone opportunity) a potential cash inflow – IF NOT REPLACED now!

This view attempts to minimize any bias towards either the defender or the challenger!

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11.1 Replacement Approach The traditional approach to conducting a replacement analysis is: The Annual Cost or Annual Worth approach!
 

With an assumed interest rate; Assumed lives for each alternative.
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11.1 Assumptions The traditional approach to conducting a replacement analysis is: The Annual Cost or Annual Worth approach!
 

With an assumed interest rate; Assumed lives for each alternative.
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11.1 Study Period for Replacement The study Period for a replacement problem may be: Finite or, Considered infinite.

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11.1 Study Period for Replacement
If Infinite then:

The required services needed are needed indefinitely; The challenger is the best available and if selected will have the same repeated cycles of costs forever! Cost estimates for every future cycle will be the same!
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11.1 Study Period for Replacement
Study Period Finite:

The previous assumptions do not hold! See Section 11.5 for a fixed study period analysis.

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Section 11.2 Economic Service Life (ESL)
The best value for “n” is not known in this type of problem. The ESL for a given asset is:

The number of years where the AW of the future costs is minimum; Using the cost estimates of all possible years that the asset may provide a needed service! Termed, “The minimum cost life”

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11.2 ESL Analysis
One estimates the ESL for the challenger and, The ESL for the current defender. Requires estimates of future operating and maintenance costs and any salvage value. Apply an Annual Worth Analysis; For assumed values of n = { 1, 2, …}
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11.2 ESL – General Format
Compute:
   

AW(i%)t =: -Capital Recovery - AW of operating costs Salvage values may be incorporated into the capital recovery term. Do this for n = 1 then n = 2, then n = … and observe the min cost “n” value.

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11.2 Minimum Cost Life
The minimum cost life is: That value of “n” that yields the lowest annual cost over the range of “n” values applied. Capital Recover topic: See Chapter 6, section 2 to review.

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11.2 Components of ESL
Capital Recovery Costs (CRC)

CRS’s generally decrease with each year of operation; The longer one uses an asset the costs associated with owning the asset are spread out over more and more time periods.
Sn n-1 n

0

1

2

////
...

Investment at t = 0 (P)

Diagram for Capital Recovery
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11.2 Capital Recovery Formula
CRC Setup
0 $P 1 2 Sn

////
...

n-1

n

CRC(i%) = -P(A/P,i%,n) + S(A/F,i%,n) CRC(i%) is the annual cost of “owing” an asset over “n” time periods
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11.2 Annual Operating Cost Component Annual Operating Costs (AOC); End-of-year estimated costs of operating the asset in question. AOC’s tend to increase over time; One wants to distribute the AOC over a range of assumed number of years; “n” = {1, then 2, then 3, …. }
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11.2 Plotting ESL
The ESL can be visualized by plotting three curve forms:
 

1. Plot the CRC’s over assumed values of “n”; 2. Plot the AOC’s over the same assumed values of “n”; Plot the sum of the CRC and AOC over the same assumed values of “n” (Total AW of AOC’s) Examine the AW plot to observe the minimum cost life of the respective asset.

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11.2 Typical ESL Plot

Min. Total AW of costs life

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11.2 AW over “k” Years
Notation:
 

P = initial investment in the asset; Sk = estimated salvage value after “k” years; AOCj = annual operating costs for year j (j = 1 to k) “k” the number of years for the analysis.

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11.2 Closed Form of AWk
Analytical Form for Total AWk:

Total AWk = − P ( A / P, i, k ) + Sk ( A / F , i, k ) −  k   ∑ AOC j ( P / F , i , j )  ( A / P , i , k )  j=1 
Procedure: Year-by-year analysis for “k” years – where “k” is given or assumed.
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11.2 Example 11.2 - Overview
Defender Asset; 3 years old now; Market value now: $13,000; 5-year study period assumed; Require Estimates of the future salvage values and annual operating costs for the 5-year period.
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11.2 Example: Future Market Values
Estimated Future Market Values and AOC’s: MktVt
    

AOCt
Mkt. $-2500 Values are decreasing: -2700 AOC’s are -3000 increasing: -3500 -4500

t = 1: $9000 t = 2: $8000 t = 3: $6000 t = 4: $2000 t = 5: $0

Assume the interest rate is 10% per year.
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11.2 Example: Find the ESL
Period – by – period analysis For “k” = 1 year:
S1 = $9000

0
P=$13,000

1
AOC1 = -2500

AW(10%)1 = (-$13,000)(A/P,10%,1) + $9000(A/F,10%,1) -2500 = -$7800 ( for one year!)
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11.2 Example: Find the ESL
Period – by – period analysis For “k” = 2 years:
S2 = $8000

0

1
AOC1 = -2500

2
AOC2 = -$2700

P=$13,000

AW(10%)2 = (-13,000)(A/P,10%,2) + 8000(A/F,10%,2) -[2500(P/F,10%,1) + 2700(P/F,10%,2)](A/P,10%,2) = -$6276/yr for 2 years.
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11.2 Example: Find the ESL
Period – by – period analysis For “k” = 3 years:
S3 = $6000

0

1
AOC1 = -2500

2
AOC2 = -$2700

3

P=$13,000

AOC3 = -$3000

AW(10%)3 = (-13,000)(A/P,10%,3) +6000(A/F,10%,3) -[2500(P/F,10%,1) + 2700(P/F,10%,2) + 3000(P/F,10%,3](A/P,10%,3) = -$6132/yr for 3 years.
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11.2 Example - continued
A similar analysis for k = 4 and 5 is conducted; The AW(10)k, K = {1,2,3,4,5} are tabulated as: Total AWk k=1: k=2: k=3: k=4: k=5: -7800 -6276 -6132 -6556 -6579
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Min. Cost Year = 3 years

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11.2 Spreadsheet Format
1 2 3 Input Parameters Interrest Rate (%) Investment Cost ($) No of Years to Study
(1) Mkt. Value $9,000.00 $8,000.00 $6,000.00 $2,000.00 $0.00

$

10.00% 13,000.00 5
(2) AOC/Yr -$2,500.00 -$2,700.00 -$3,000.00 -$3,500.00 -$4,500.00

Base Input Parameters

Year 1 2 3 4 5

Schedule of Est. Mkt. Values And AOC’s/year Tabulation of CRS’s, AOC’s and Total AW(i%)
Min Life ID

(3) Cap. Rec. Costs -$5,300 -$3,681 -$3,415 -$3,670 -$3,429

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(4) AW of AOC's -$2,500 -$2,595 -$2,718 -$2,886 -$3,150

Year 1 2 3 4 5

(5) Total AW(i%) -$7,800 -$6,276 -$6,132 -$6,556 -$6,580

Min Life

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(3) Cap. Rec. Costs -$5,300 -$3,681 -$3,415 -$3,670 -$3,429

11.2 Specimen Cell Formulas: CRCk
(4) AW of AOC's -$2,500 -$2,595 -$2,718 -$2,886 -$3,150 Year 1 2 3 4 5 (5) Total AW(i%) -$7,800 -$6,276 -$6,132 -$6,556 -$6,580

Min Life ID

Min Life

=IF($B18>$C$14,"",PMT($C$12,$B18,$C$13,-$C18))
Note: Application of the PMT financial function!

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11.2 Specimen Cell Formulas: AW(AOC)
(3) Cap. Rec. Costs -$5,300 -$3,681 -$3,415 -$3,670 -$3,429 (4) AW of AOC's -$2,500 -$2,595 -$2,718 -$2,886 -$3,150 Year 1 2 3 4 5 (5) Total AW(i%) -$7,800 -$6,276 -$6,132 -$6,556 -$6,580 Min Life ID

Min Life

=IF($B18>$C$14,"",-PMT($C$12,$B18,NPV($C$12,$D$17:$D18)+0))

Note: Application of the PMT financial function in combination with the NPV function for AW of AOC’s!

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11.2 Specimen Cell Formulas: Total AW (3) (4) (5) Min Life
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Cap. Rec. Costs -$5,300 -$3,681 -$3,415 -$3,670 -$3,429

AW of AOC's -$2,500 -$2,595 -$2,718 -$2,886 -$3,150

Year 1 2 3 4 5

Total AW(i%) -$7,800 -$6,276 -$6,132 -$6,556 -$6,580

ID

Min Life

=IF($B18>$C$14,"",-PMT($C$12,$B18,NPV($C$12,$D$17:$D18)+0))

PMT and NPV function to compute the total AW year by year.

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11.2 Building a Plotting Table
Table below is used for Plotting Purposes NO Data Entry required! year 1 2 3 4 5 CRC $5,300.00 $3,680.95 $3,414.80 $3,670.18 $3,429.37 AOC $2,500 $0 $2,718 $2,886 $3,150 AW $7,800 $3,681 $6,132 $6,556 $6,580

Summary Table from the spreadsheet to assist in plotting the curve forms

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11.2 Plot of Capital Recovery Costs
ESL
CRC $6,000.00 $5,000.00 $4,000.00 $AW $3,000.00 $2,000.00 $1,000.00 $0.00 0 1 2 3 Years
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5

6

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11.2 Plot of the AOC’s
ESL
AOC $3,500 $3,000 $2,500 $AW $2,000 $1,500 $1,000 $500 $0 0 1 2 3 Years 4 5 6

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11.2 Combined Plots for Example
ESL
CRC $9,000.00 $8,000.00 $7,000.00 $6,000.00 $AW $5,000.00 $4,000.00 $3,000.00 $2,000.00 $1,000.00 $0.00 0 1 2 3 Years
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AOC

AW

Min AW Year!

4

5

6

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11.2 ESL vs. AW Analysis
Traditional AW Analysis:
  

“n” is fixed or assumed; First cost at t = 0; Est. salvage value at t = “n”;

ESL Analysis:

 

“n” varies from t = 1 to t = “k:
Year-by year analysis using AW(i%) Table of possible future salvage (market) values for the asset in question. Table of future AOC’s, year by year.
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11.2 ESL vs. AW
AW analysis is for a fixed time period with a table of AOC’s and one estimated future salvage value out at t = “n”. ESL is a period-by-period variant of AW where a table of estimated future salvage values may be provided and a tabulation of a set of AW’s for each time period evaluated. Seeking the min. AW life in an ESL analysis.

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11.2 Important Conclusions
If “n” fixed (known) then determine the AW(i%) for “n” time periods. This is the ESL given “n”. This is the correct value to use in a replacement study!

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11.2 “n” Not Known
For “n” of a defender or challenger that is not known or assumed: Compute the ESL for a range of “n” values where n = {1, then 2, …, then K}; From this period-by-period analysis, determine the min cost life and the associated AW for that life.
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11.2 “n” Not Known
Will need a table of future, estimated market (salvage) values for the asset in question and a table of the future estimated annual operating costs. For estimating future market values can:
 

Apply a sequence of % loss of value; See Chapter 15 for other cost estimating techniques.

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11.2 Marginal Cost Approach
Marginal Costs are year-by-year estimates of the costs to:
  

Own the asset and, Operate the asset, For the current year in question. 1. Cost of ownership (loss in Mkt. Value/yr; 2. Foregone interest of Mkt. Value at beg. Of the year; 3. AOC for each year.

Three Components of Marginal Costs:
 

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11.2 Marginal Cost Analysis
Compute the marginal costs per year; Find their equivalent annual worth; AW of marginal costs = total AW of costs; Can perform either a ESL analysis or a Marginal Cost analysis when yearly Mkt. Values are estimated; Same result!

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11.2 Marginal Cost Format: Example 11.2
Year 1 2 3 4 5 MV $9,000 $8,000 $6,000 $2,000 $0 Loss in MV for Year -$4,000.00 -$1,000.00 -$2,000.00 -$4,000.00 -$2,000.00 Lost Interest on MV for Year -$1,300.00 -$900.00 -$800.00 -$600.00 -$200.00 Est. AOC/Year -$2,500.00 -$2,700.00 -$3,000.00 -$3,500.00 -$4,500.00

time 1 2 3 4 5

Marginal Cost For the Year -$7,800.00 -$4,600.00 -$5,800.00 -$8,100.00 -$6,700.00

AW of Marginal Costs -$7,800 -$6,276 -$6,132 -$6,556 -$6,580

Min. Cost Life: At t = 3. Same Result as The ESL analysis.

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11.2 Specific Conclusions:
1. To perform an ESL analysis yearby-year market value estimates are made relative to the specific asset;
Determine the “n” value with the lowest AW of costs; The “n” value and the associated AWn are then used in the replacement analysis.

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11.2 Specific Conclusions:
2. If no estimates of future market
values are made and “n” is fixed then:
  

Fix “n”; Estimate Sn; Calculate AW over “n” years given P and S; Use the “n” and AW given “n” in the replacement analysis for the specific asset.
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11.2 Setting Up for a Replacement Analysis Conduct the ESL for the defender and the challenger(s); Form the following alternatives:

Challenger Alternative (C): AWC for nC yrs; Defender Alternative: (D): AWD for nD yrs.

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11.2 Begin the Evaluation

The next section (11.3) illustrates how to conduct a before-tax replacement study.

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CHAPTER 11

Section 11.3 Performing a Replacement Study
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11.3 Two Ways to Perform the Study
1. Without a specified study period; 2. With a specified study period

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11.3 Overview of the two Methods

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11.3 New Replacement Study
Given: {(C) or (D)}; Apply:
 

AWD vs. AWC Select the best alternative  Stay with the Defender for nD years or,
 Go with the challenger for nC years.

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11.3 One-Year Later Analysis
Validate all cost and market value estimates; Is the current year nD?
 

If “YES”, replace the defender with (C); If “NO”, retain defender for one more year and re-evaluate then. Update all estimates Calculate AWC and AWD Initiate a new replacement study.
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If cost estimates have changed then:
  

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11.3 Case Problem ( Ex. 11.4) Defender Defender Data
     

Current Market Value: $15,000; Future Mkt. Values will decrease by 20%/yr; Keep for no more than 3 years; AOC’s: {$4,000,$8,000,$12,000} Retrofit next year = $16,000; AOC’sD := {$20,000, $8,000,$12,000} (costs).

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11.3 Case Problem: Challenger
First Cost: $50,000 Future Mkt. Values decreasing by 20%/year; Retain for no more than 5 years; AOC’sC :=
{$5,000,$7,000,$9,000,$11,000,$13,000} Assume the interest rate is set at 10%/year.

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11.3 Defender Analysis
Input Parameters Interrest Rate (%) Investment Cost ($) No of Years to Study $ 10.00% 15,000.00 3
(2) AOC/Yr -$20,000.00 -$8,000.00 -$12,000.00
Min Life ID

Year 1 2 3
(3) Cap. Rec. Costs -$4,500 -$4,071 -$3,711 (4) AW of AOC's -$20,000 -$14,286 -$13,595

(1) Mkt. Value $12,000.00 $9,600.00 $7,680.00

Year 1 2 3

(5) Total AW(i%) -$24,500 -$18,357 -$17,307

Min Life

ESL(Defender) = 3 yrs: AW = -$17,307/year
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11.3 Cost Plots for Defender
ESL
CRC $30,000.00 $25,000.00 $20,000.00 $AW $15,000.00 $10,000.00 $5,000.00 $0.00 0 1 Years 2 3 AOC AW

Min AW Cost Life = 3 years
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11.3 Example 11.4: Challenger
Input Parameters Interrest Rate (%) Investment Cost ($) No of Years to Study
Year 1 2 3 4 5

$
(1) Mkt. Value $40,000.00 $32,000.00 $25,600.00 $20,480.00 $16,384.00

10.00% 50,000.00 5
(2) AOC/Yr -$5,000.00 -$7,000.00 -$9,000.00 -$11,000.00 -$13,000.00

AWC = -19,123/year
Min Cost Life N = 4 Years

(3) Cap. Rec. Costs -$15,000 -$13,571 -$12,372 -$11,361 -$10,506

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(4) AW of AOC's -$5,000 -$5,952 -$6,873 -$7,762 -$8,620

Year 1 2 3 4 5

(5) Total AW(i%) -$20,000 -$19,524 -$19,245 -$19,123 -$19,126
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11.3 Challenger Plots
AW $20,100 $20,000 $19,900 $19,800 $19,700 $19,600 $19,500 $19,400 $19,300 $19,200 $19,100 $19,000 0 1 2

ESL: Challenger
Min Cost Life = 4 years At -$19,123/year

$AW

3 Years

4

5

6

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11.3 Case Problem: Summary
AWD = -$17,307/year; nD = 3 years; AWC = -$19,123/year; nC = 4 years;
Conclusion: Stay with the Defender for at least one more year – lowest AW(10%) cost: -$17,307/yr vs. $19,123/yr.
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11.3 Market Value of Defender
What minimum market value of the defender will make the current challenger economically attractive? If a high enough market value (tradein) is possible for the defender asset, one should do so and go with the Challenger immediately! Break-even or replacement value (RV)

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11.3 Replacement Value (Defender)
Economic Fact:

If the actual market value (trade-in) exceed the breakeven replacement value, the challenger is the better alternative. If this is the case, replace now with the challenger!

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11.3 RV Analysis
If a spreadsheet analysis has been conducted, one may use:
 

Goal Seek to find the RV or, SOLVER provided the cells are properly linked.

Build you own spreadsheet to gain the experiences needed – replacement problems are difficult when one applies manual calculations.
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CHAPTER 11

Section 11.4 Additional Considerations in a Replacement Study
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11.4 Three Additional Considerations 1. Future-year Replacement
Decisions;

2. Opportunity-cost vs. Cash Flow
approaches;

3. Anticipation of improved future
challengers.

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11.4 Future Replacement Decisions 1.
Future-year Replacement Decisions:  Replace now? One year from now? Two years from now?  The procedure just presented does assist with answering this question provided:
The cost estimates for (C) and (D) do not change!

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11.4 Future Replacement Decisions
1. Future-year Replacement
Decisions:
If cost estimates change for either (D) or (C) then the analysis should be initiated again within a reasonable time frame. With changing estimates the decision to replace may be altered!

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11.4 Opportunity Cost vs. Cash Flow
2. The method just presented applies the
opportunity cost approach:
(D)’s investment now is the fair market value of (D) now; Represents the opportunity cost foregone by not disposing of (D) now; (C)’s investment now is the investment in (C) now.

This is a correct approach for a replacement analysis.

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11.4 Cash Flow Approach
2. Cash Flow Approach: Assumes that when the challenger is selected and a cash inflow for the defender is received then:

The investment in the challenger is immediately reduced. Discourage this approach; Works only if the lives of the (C) and (D) are the same!

 

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11.4 Anticipation of Future Challengers
3. Assumption: At some time in the future a worthy challenger will appear and replace the defender.

Always study future trends of challengers; May be best to augment the defender until such time a more worthy challenger becomes available. Tax considerations should always be involved (see Chapter 17)

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Section 11.5 Replacement Study over a Specified Study Period
At times, a fixed or “impressed” study period will apply to both the challenger and the defender. Such a study may not be based upon the ESL approach. If a fixed study period then ……

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11.5 Specified Study Period
At times, a fixed or “impressed” study period will apply to both the challenger and the defender. Such a study may not be based upon the ESL approach. If a fixed study period then ……

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11.5 Specified Study Period
Determine the AW for both C and D over the prescribed study period; No need to perform an ESL analysis; Assumption is that the services of C and D are not needed beyond the study period. Use the AW approach.

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11.5 Specified Study Period
Focus on the most accurate estimates available over the fixed study period. Assume “equal service” for both D and C over the study period. What happens IF the defender’s remaining life is shorter than the study period?

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11.5 Defender’s Remaining Life
If the defender’s remaining life is shorter than the study period then: Focus on upgrading the defender and obtain cost estimates in order to extend the defender out to the study period. These costs become part of retaining the defender out to the prescribed study period.

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Chapter 11 Summary
Compare the best challenger to the current defender; “Best” is defined as the option with the lowest AW of costs over the specified period of time; Apply the ESL method to find the economic life of the defender and challenger;

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Chapter 11 Summary cont.
For ESL, need estimates of future market values and annual operating costs for both C and D. Annual Worth is the best method especially if the lives of each alternative are different. For a fixed study period for both D and C, apply the traditional AW method.
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Chapter 11 Summary cont.
Always focus on the estimates of future costs and salvage values using sound principles of estimation.

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ENGINEERING ECONOMY Sixth Edition Blank and Tarquin

CHAPTER 5 End of Slide Set

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