ECON 2004

Engineering Economy

Spring 2020

Week

9
Chapter 9
Replacement Analysis
Economic Life of Assets
 ECON 2004 – Engineering Economy
Chapter 9 - Replacement Analysis
Replacement Analysis using PW [or AW]
A firm owns an eqipment that it is considering replacing.
The old equipment has expenses of 60.000 $ per year
and it can be kept for 5 more years,
at which time it will have 0 (zero) Market Value, MV (i.e. Salvage Value).
It is believed that 30.000 $ could be obtained for the old equipment
if it were sold now.
The new equipment can be purchased for 120.000 $.
It will have a Market Value of 50.000 $ in 5 years
and it will have expenses of 30.000 $ per year until that time.

Using a before-tax Minimum Attractive Rate of Return, MARR of 20% per year,
determine whether or not the old equipment should be replaced.
A study period of 5 years is appropriate.
 u Please state how the decision should be made.
Alternative with PW or AW that is smaller in absolute value (i.e. with lesser costs) should be preferred.
No revenues or savings are taken into account, as they are the same for both alternatives.
v Please show your calculations in the table below:
"Investment Value" of the Old Equipment is actually the opportunity cost of not selling.
MARR Old Equipment S PW New Equipment S PW
20% Investment Salvage Annual -209.437 Investment Salvage Annual -189.624
t
1/(1+MARR) t Value Value Expenses PWt Value Value Expenses PWt
1,0000 0 -30.000 -30.000 -120.000 -120.000
0,8333 1 -60.000 -50.000 -30.000 -25.000
0,6944 2 -60.000 -41.667 -30.000 -20.833
0,5787 3 -60.000 -34.722 -30.000 -17.361
0,4823 4 -60.000 -28.935 -30.000 -14.468
0,4019 5 0 -60.000 -24.113 50.000 -30.000 8.038
(A/P,20%,5) -70.031 -63.407
0,3344 2,4883 EUAC EUAC
t t
= [ MARR * (1+MARR) ] / [(1+MARR) -1] Annual Worth, AW: Equivalent Uniform Annual Cost, EUAC

w What is your recommendation? And, why?

The old equipment should be replaced immediately as it is estimated to have higher annual costs, EUAC.
 ECON 2004 – Engineering Economy
Chapter 9 - Replacement Analysis
Economic Life of an Asset
The asset should be retained in service until minimum annual cost is reached.
 ECON 2004 – Engineering Economy
Chapter 9 - Replacement Analysis - Questioning the Duration
Economic Life of a [New] Asset
A new forklift truck will require an investment of 45.000 $ and is expected to have year-end
Market Value, MV and annual expenses, E as shown below. If before-tax MARR is 9% per year,
how long should the asset be retained in service? (What is the economic life of the new asset?)
u Please state how the decision should be made.
The asset (the new forklift truck) should be retained in service until the end of the year
when the minimum Equivalent Uniform Annual Cost, EUAC shall be reached.
In other words, it should be used until the end of its economic life.
MARR (e) = 9% v Please show your calculations in the table below:
Year- [1] [2] [3] 1+2+3 Accumulated
End Loss in Total PW at t=0 EUAC
Market Market Cost of Annual Annual 1 PW of TCt through
Value Value Capital Exp t
Cost (1+e) at t=0 through Year
t MVt DMVt MVt-1*e Et TCt of TCt Year t (A/P,e,t) t
0 45.000
1 32.000 13.000 4.050 4.000 21.050 0,9174 19.312 19.312 1,0900 21.050
2 23.000 9.000 2.880 5.000 16.880 0,8417 14.208 33.519 0,5685 19.055
3 17.000 6.000 2.070 7.000 15.070 0,7722 11.637 45.156 0,3951 17.839
4 12.000 5.000 1.530 10.000 16.530 0,7084 11.710 56.867 0,3087 17.553 min
5 8.000 4.000 1.080 14.000 19.080 0,6499 12.401 69.267 0,2571 17.808
6 5.000 3.000 720 19.000 22.720 0,5963 13.547 82.814 0,2229 18.461

w Please write down your answer into the box below: 4 years
 ECON 2004 – Engineering Economy
Chapter 9 - Replacement Analysis
Questioning the Duration Economic Life of an Asset [in-Use]

A forklift has been in-use for some time has a present Market Value, MV of 12.000 $.
If kept, MV and annual expenses, E are estimated to be as shown below.
Before-tax MARR is 9% per year,
how long should the asset be retained in service?
(What is the remaining economic life of the asset in-use?)
Year-End
Market Annual
Value Expenses
t MVt Et
0 12.000
1 9.000 11.500
2 6.000 13.800
3 3.000 18.000
4 1.000 25.000
 A forklift that has been in-use for some time has a present Market Value, MV of 12.000 $. If kept, MV
and annual expenses, E are estimated to be as shown below. Before-tax MARR is 9% per year,
how long should the asset be retained in service? (What is the remaining economic life of the asset in-use?)
u Please state how the decision should be made.
The asset-in-use (the forklift) should be retained in service until the end of the year when the minimum Equivalent
Uniform Annual Cost, EUAC shall be reached. In other words, it should be used until the end of its economic life.
MARR (e) = 9% v Please show your calculations in the table below:
Year- [1] [2] [3] 1+2+3 Accumulated
End Loss in Total PW at t=0 EUAC
Market Market Cost of Annual Annual 1 PW of TCt through
Value Value Capital Exp Cost (1+e) at t=0
t
through Year
t MVt DMVt MVt-1*e Et TCt of TCt Year t (A/P,e,t) t
0 12.000
1 9.000 3.000 1.080 11.500 15.580 0,9174 14.294 14.294 1,0900 15.580 min
2 6.000 3.000 810 13.800 17.610 0,8417 14.822 29.116 0,5685 16.551
3 3.000 3.000 540 18.000 21.540 0,7722 16.633 45.748 0,3951 18.073
4 1.000 2.000 270 25.000 27.270 0,7084 19.319 65.067 0,3087 20.084
w How long should the asset be retained in service? (What is the remaining economic life of the asset in-use?)
As EUAC is minimum in year 1,
the forklift-in-use should be replaced as soon as possible (i.e. at the end of year zero),
if a better alternative is available.
 ECON 2004 – Engineering Economy EUAC through year t
Chapter 9 - Replacement Analysis
When should the replacement be done?
The fork-lift in-use should be replaced
when a better alternative
(with a lower EUAC)
becomes available.
New Forklift
EUAC
min EUAC of
through
new forklift
Year
Forklift-in-use
t t
EUAC
0
1 21,050 through
2 19,055 Year
3 17,839 t t
4 17,553 min 0
5 17,808 1 15,580 min
6 18,461 2 16,551
3 18,073
4 20,084
 ECON 2004 – Engineering Economy
Chapter 9 - Replacement Analysis - Questioning the Duration
When should the replacement be done?
Forklift-in-use New Forklift What if
EUAC EUAC another alternative
through through is available?
Year Year Then,
t t t t better alternative
0 0 should be chosen
1 15.580 1 21.050 first
2 16.551 < 17.553 2 19.055 by comparing
3 18.073 > 17.553 3 17.839 their min EUAC's.
4 20.084 4 17.553 min
As EUAC is minimum in year 1, the forklift-in-use 5 17.808
should be replaced as soon as possible 6 18.461
(i.e. at the end of year zero),
if a better alternative is available.
A better alternative will be available after the end of year 2 when
EUACforklift-in-use year2 (16,551 $) < min EUACnew-forklift (17,553 $) < EUACforklift-in-use year3 (18,073 $).
So, it would be most economical to keep the forklift-in-use for 2 more years
and then to replace it with the New Forklift after the end of year 2.