Replacement Analysis

Replacement Analysis
Course Details: Engineering Economy & Management

Department of Mechanical Engineering (MEC2450)
Z.H. College of Engineering & Technology Topic: Replacement Analysis
Aligarh Muslim University 1 By: Faisal Hasan (Associate Professor)
Email: f.hasan.me@amu.ac.in
Why?
• To address the question of whether a currently owned asset should be kept in service or
replaced with a similar one.
• If Replaced, When?
Examples:
• Replacing of worn out tyres
• Replacing an old phone with a new one (similar functions) but improved battery life.
• Replacing a petrol car with an electric car.
• Replacing a CRT monitor with a LED monitor.

What to do with an existing asset?
• Keep it (Continue using the same)
• Abandon it (do not replace)
• Replace it, but keep it for backup purposes
• Augment the capacity of the asset, if required
• Dispose of it, and replace it with another

Reasons to Replace
• Deterioration
• Worn out, Wear and tear
• Physical impairment
• Obsolescence
• Altered requirements
• Availability of new and improved technology.

Terminology
• Defender: The present asset (already In-use/housed/installed)

• Challenger: Alternative asset available to replace the defender.
• Economic Life: the period of time (years) that yields the minimum equivalent
uniform annual cost (EUAC) of owning and operating as asset.
• Ownership Life: the period between acquisition and disposal by a specific owner
• Physical Life: period between original acquisition and final disposal over the
entire life of an asset.
• Useful life: the time period an asset is kept in productive service (primary or
backup).

Replacement: The outsider’s viewpoint
• The outsider viewpoint is the perspective taken by an impartial third party

to establish the fair MV of the defender. Also called the opportunity cost
approach.
• The opportunity cost is the opportunity foregone by deciding to keep an
asset.
• If an upgrade of the defender is required to have a competitive service
level with the challenger, this should be added to the present realizable
MV.

Problem 1
Consider a 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
Year Defender D Challenger C
0 5000 7500
1 1700 500
2 2000 1100
3 2500 1300
For a given MARR=12%, should the defender be replaced?

Solution 1
Since, the EAC(C)<EAC(D), Defender must be Replaced

Problem 2
A second challenger (CX) competes with the defender (D) that has a current
market value of $5000 and operating expenses given in the table. This
challenger (CX) has a purchase price of $9000, but $6000 is offered for the
defender as a trade-in and the seller guarantees that the operating costs will be
no more than &800 per year. Should the offer be accepted when MARR=12%
and no salvage value is expected at the end of challenger CX’s 3-year life
Year Defender D Challenger CX
0 5000 9000
1 1700 800
2 2000 800
3 2500 800

Solution 2
It’s a case of Inflated Salvage Value of the Defender

The Difference between a known marker value ($5000 in this case) and a seller’s higher offer is
treated as a reduction in the challenger’s purchase price [9000-(6000-5000) =8000, in this case]
Since, the EAC(CX)>EAC(D), Defender must be

not be Replaced

Defender and Challenger with Unequal Lives
Repeatability assumption for the defender is unrealistic as its an old equipment exhibiting
decreased efficiency and its hard to find a identical one. However, it holds good for the Challenger
Year Defender D Challenger CXX Challenger (CXX)

$2000
0 5000 12000
1 1700 700 0 1 2 3 4 5
2 2000 700
3 2500 700
4 -- 700 $700 Each
5 -- 700 $12000
Salvage 0 (end of 3 years) 2000 (end of 5 years)
Value

When to Replace?
Consider the following data pertaining to microcomputers. Given that

(EAC)challenger=$40000; MARR=10%. Should the defender be placed? If so, when?
EOY Trade-in value ($) Annual Maintenance costs ($) Annual Operating costs ($)
0 12000 -- --
1 8000 5000 28000
2 3000 6500 32000
$3000
$12000 $(28000+5000)
=$33000
$(32000+6500)
=$38500
Since, (EAC)Def>(EAC)Cha, thus defender needs to be replaced

When to Replace, cont..
Calculating EAC for the defender, year by year

For Year 1 (keeping the defender just for year 1) For Year 2 (keeping the defender just for year 2
Since, (AC for Year-2)Def>(EAC)Cha

Since, (AC for Year-1)Def<(EAC)Cha
Thus defender needs to be replaced during Year-2
Thus defender needs not to be replaced during Year-1
with the given challenger

Problem 3
A grinder was purchased 3 years ago for $40000. It has provided adequate service, but an improved version is now available for
$35000 that will reduce the operating costs and cut inspection expenses. Cost and salvage values for the two machines are given in the
table. Costs that are same for either machine are not included. Also, the operating costs for the challenger are very low due to warranted
equipment. Should a replacement be made if the required MARR is 15% and the service of grinder will be needed for only 4 more
years?
Defender D Challenger C
Year
Operating Cost ($) Salvage Value (S) Operating Cost ($) Salvage Value (S)
0 - 12000 -- 35000
1 3400 7000 200 30000
2 3900 4000 1000 27000
3 4600 2500 1200 24000
4 5600 1000 1500 20000
5 2000 17000
6 2600 15000

Solution
Why for
6 years?

Solution
This is same as replacing the defender Now i.e. beginning of year-1
Replacement be done EACdef EACCha Decision

At the beginning of year 1 (Now, CF for year 1,2,3,4) $ 8252 $ 9157 No
At the beginning of year 2 (CF for years 2,3,4)
At the beginning of year 3 (CF for years 3,4)
At the beginning of year 4 (CF for year 4)

Replacing at beginning of year 2

At the beginning of year 2 (CF for years 2,3,4) $7399 $ 9170 No
At the beginning of year 3 (CF for years 3,4)


At the beginning of year 3 (CF for years 3,4) $7061 $ 9543 No


At the beginning of year 3 (CF for years 3,4) $7061 $ 9543 No
At the beginning of year 4 (CF for year 4) $7475 $10450 No


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Replacement Analysis

Course Details: Engineering Economy & Management

• Replacing of worn out tyres

• Replacing a petrol car with an electric car.

• Replacing a CRT monitor with a LED monitor.

Course Details: Engineering Economy & Management

• Keep it (Continue using the same)

• Abandon it (do not replace)

• Replace it, but keep it for backup purposes

• Augment the capacity of the asset, if required

• Dispose of it, and replace it with another

Course Details: Engineering Economy & Management

Course Details: Engineering Economy & Management

• Defender: The present asset (already In-use/housed/installed)

Course Details: Engineering Economy & Management

• The outsider viewpoint is the perspective taken by an impartial third party

Course Details: Engineering Economy & Management

Consider a choice between a defender that has a current market value of

For a given MARR=12%, should the defender be replaced?

Course Details: Engineering Economy & Management

Since, the EAC(C)<EAC(D), Defender must be Replaced

Course Details: Engineering Economy & Management

Course Details: Engineering Economy & Management

It’s a case of Inflated Salvage Value of the Defender

Since, the EAC(CX)>EAC(D), Defender must be

Course Details: Engineering Economy & Management

Year Defender D Challenger CXX Challenger (CXX)

Course Details: Engineering Economy & Management

Consider the following data pertaining to microcomputers. Given that

Course Details: Engineering Economy & Management

Calculating EAC for the defender, year by year

Since, (AC for Year-2)Def>(EAC)Cha

Course Details: Engineering Economy & Management

Course Details: Engineering Economy & Management

Course Details: Engineering Economy & Management

This is same as replacing the defender Now i.e. beginning of year-1

Replacement be done EACdef EACCha Decision

Course Details: Engineering Economy & Management

Replacement be done EACdef EACCha Decision

Course Details: Engineering Economy & Management

Replacement be done EACdef EACCha Decision

Course Details: Engineering Economy & Management

Replacement be done EACdef EACCha Decision

Course Details: Engineering Economy & Management

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