Ch13 Replacement Class
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Transcript of Ch13 Replacement Class
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Copyright Oxford University Press 2009
Chapter 13
Replacement Analysis
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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
Chapter Outline
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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 replacementanalysis problems
Learning Objectives
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Should the existing equipment be retained orreplaced?
The Defender is the existing equipment.
The Challenger is the best available
replacement equipment.
If the defender proves more economical, it will
be retained. If the challenger proves moreeconomical, it will be installed.
Replacement Analysis
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Obsolescenceoccurs when an assets technologyis surpassed by newer and/or differenttechnologies (PC)
Depletionis the gradual loss of market value of anasset as it is being consumed or exhausted (Oilwell, Timber)
Deteriorationis the general loss in value of anasset due to aging process (Production machinery)
The Replacement Problem
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Planned replacements can be scheduled to minimizethe time and cost of disruptions.
Variations of replacement problems, such asabandonment, retirement, improvements of defender
or keeping defender as spare, can be considered aspotential new challenger.
Since replacement problems usually are consideredwith fixed output, only costs of defender and
challengers are analyzed. Due to the lives of the defender and challengers areusually different, most calculations focus on annualmarginal costs or on EUAC.
The Replacement Problem
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Replacement AnalysisDecision Map
Identify Alternatives Best ChallengerDefender
DefenderMarginal Cost Data?
Analysis Technique 3:Defenders EUACover its remaining lifeChallengers EUACat its min. cost life
Analysis Technique 2:Defenders lowestEUACChallengersEUAC at its minimumcost life
DefenderMarginal CostIncreasing?
Available
Find EUACover given life
Not Available
Find lowest EUACfor Defender
No
Analysis Technique 1:Defenders next yearmarginal costChallengers EUAC
Yes
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The minimum cost life of any new asset is the number ofyears at which the EUAC of ownership is minimized.
Because of increasing operating and maintenancecosts, the minimum cost life is often shorter than the
assets useful life. EUAC for each possible life, less than or equal to the
useful life, is determined. The number of years atwhich the EUAC is minimum can then be identified.
Minimum Cost Life of a New Asset
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Example 13-1Minimum Cost Life of a New Asset
EUAC(O&M) CR EUAC(Total)$500 $8,100 $8,6001,125 4,206 5,3311,733 2,910 4,6442,325 2,264 4,590*
2,900 1,878 4,7793,459 1,622 5,0824,002 1,441 5,4424,528 1,305 5,8335,038 1,201 6,2395,533 1,118 6,650
6,011 1,051 7,0626,474 995 7,4706,922 949 7,8717,355 910 8,2657,773 876 8,649
Year Maint. Operating O&M1 $0 $500 $5002 900 900 1,8003 1,800 1,300 3,1004 2,700 1,700 4,400
5 3,600 2,100 5,7006 4,500 2,500 7,0007 5,400 2,900 8,3008 6,300 3,300 9,6009 7,200 3,700 10,900
10 8,100 4,100 12,200
11 9,000 4,500 13,50012 9,900 4,900 14,80013 10,800 5,300 16,10014 11,700 5,700 17,40015 12,600 6,100 18,700
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Example 13-1Minimum Cost Life of a New Asset
0
2000
4000
6000
8000
10000
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Year
Cost
Capital Recovery
O&M
Total EUAC
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Replacement AnalysisDecision Map
Identify Alternatives Best ChallengerDefender
DefenderMarginal Cost Data?
Analysis Technique 3:Defenders EUACover its remaining lifeChallengers EUACat its min. cost life
Analysis Technique 2:Defenders lowestEUACChallengersEUAC at its minimumcost life
DefenderMarginal CostIncreasing?
Available
Find EUACover given life
Not Available
Find lowest EUACfor Defender
No
Analysis Technique 1:Defenders next yearmarginal costChallengers EUAC
Yes
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Are the defender marginal cost data available? Are the defender marginal costs increasing? The total marginal cost for any year can include:
Capital recovery cost (loss in market value andloss 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 equivalentend-of-year cash flow
Defenders Marginal Cost Data
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Example 13-2Marginal Cost Calculation
YearMarketValue
CapitalRecovery O&M
Cost ofBreakdown
Risk
TotalMarginal
Cost1 $18,000 $10,750 $2,000 $5,000 $17,750
2 13,000 7,700 2,500 5,000 15,2003 9,000 5,950 3,000 5,000 13,9504 6,000 4,350 3,500 6,500 14,3505 4,000 2,900 4,000 8,000 14,9006 3,000 1,600 4,500 9,500 15,600
7 2,500 950 5,000 11,000 16,950Capital Recovery Cost = MVN-1(A/P, 15%, 1)MVN(A/F, 15, 1)
= MVN-1(1+15%)MVN(1)= (MVN-1MVN) + MVN-1(15%)
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Example 13-3Marginal Cost Calculation
YearMarketValue
CapitalRecovery
OperatingCost
TotalMarginal
Cost0 $15,000
1 14,000 $3,250 $10,000 $13,2502 13,000 3,100 11,500 14,6003 12,000 2,950 13,000 15,9504 11,000 2,800 14,500 17,3005 10,000 2,650 16,000 18,650
Capital Recovery Cost = MVN-1(A/P, 15%, 1)MVN(A/F, 15, 1)= MVN-1(1+15%)MVN(1)= (MVN-1MVN) + MVN-1(15%)
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Maintain the Defender as long as themarginal cost of ownership for one moreyear is less than the Challengers minimum
EUAC. When the Defenders marginal cost
becomes greater than the Challengersminimum EUAC, then replace the Defender
with the Challenger.
Replacement Analysis Technique 1:Defender Marginal Cost Increasing
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Currently available best Challenger willcontinue to be available in subsequent yearsand will be unchanged in its economic costs.
When the Defender is ultimately replaced, itwill be replaced with this Challenger. The period of needed services of the asset
is indefinitely long.
Replacement RepeatabilityAssumption
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Calculate the Defenders minimum EUAC. If the Defenders minimum EUAC exceeds the
Challengers minimum EUAC, then replaceimmediately.
If the Defenders minimum EUAC is lower than theChallengers minimum EUAC, then the Defenderwill be kept at least the minimum cost life.
After the minimum cost life, then replace when theDefenders increasing marginal cost exceeds theChallengers minimum EUAC.
Replacement Analysis Technique 2:Defender Marginal Cost Not Increasing
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Example 13-5Replacement Analysis Technique 2
Year
ChallengerMarginal
CostChallenger
EUAC1 $17,750 $17,750.00
2 15,200 16,563.953 13,950 15,811.204 14,350 15,518.575 14,900 15,426.83*6 15,600 15,446.61
7 16,950 15,582.46
Year
DefenderMarginal
CostDefender
EUAC1 $16,000 $16,000.00
2 14,000 $15,069.773 13,500 $14,617.71*4 15,300 $14,754.355 17,500 $15,161.57
)N%,15,PA]()j%,15,FP)(Cost(Marginal[UACE N
1j j
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Example 13-6Finding Minimum Cost Life
YearMarketValue
CapitalRecovery O&M
MarginalCost EUAC
0 $5,000
1 4,000 $1,500 $0 $1500 $1,500.002 3,500 900 100 1000 1,261.903 3,000 850 200 1050 1,197.894 2,500 800 300 1100 1,176.795 2,000 750 400 1150 1,172.416 2,000 200 500 700 1,111.18
72,000
200 600 800 1,078.388 2,000 200 700 900 1,062.789 2,000 200 800 1000 1,058.16*10 2,000 200 900 1100 1,060.7811 2,000 200 1,000 1200 1,068.29
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Example 13-7Replacement Analysis Technique 2
YearChallenger
EUAC1 $8,6002 5,3313 4,6444 4,590*5 4,779
Year
DefenderOverhaul
CostDefender
O&M
DefenderMarginal
CostDefender
EUAC0 $4,0001 $1,800 $6,120 $6,120.00
2 1,800 1,800 4,043.083 2,800 2,800 3,660.17*4 3,800 3,800 3,691.205 4,800 4,800 3,880.20
)N%,8,PA]()j%,8,FP)(Cost(Marginal[UACE N
1j j
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Calculate the Defenders EUAC over its stateduseful life.
If the Defenders EUAC exceeds the Challengersminimum EUAC, then replace immediately.
If the Defenders EUAC is lower than theChallengers minimum EUAC, then the Defenderwill be kept.
Replacement Analysis Technique 3:Defender Marginal Cost Not Available
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Present market value, not the trade-in value,should be assigned as the first cost of theDefender.
The first cost of the Challenger should include thepurchase price, sales tax, installation cost, andother items that occur initially on a one-time basisif the Challenger is selected.
The Defenders potential market (or salvage) value
should not be subtracted from the Challengersfirst cost.
Defining First Costs ofDefender and Challenger
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Defender: SK-30, purchased 2 years ago for $1600, wasdepreciated with SL using 4-year life and 0 salvage.
Challenger: EL-40, $1200 with a trade-in allowance of $350for the SK-30; $1050 without a trade-in.
Current price for new SK-30 is $995.
Example 13-8Defining Defender First Cost
Defender: SK-30, Original cost: $1600 (Basis for SL depreciation) Present cost: $995 (Irrelevant)
Book value: $800 (Useful in determining depreciationrecapture or loss)
Trade-in value: $350 (Irrelevant) Market value: $200 (First cost assigned to Defender)
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Circumstances where Repeatability Assumption maynot apply:
When there is a specific study period instead of anindefinite need for the asset
When future Challengers are not assumed to beidentical to the current best Challenger
Repeatability AssumptionNot Acceptable
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A Closer Look at Future Challengers
It seems likely that futurechallengers will be betterthan the present Challenger
The prospect of better
future challengers maymake it more desirable toretain the Defender and toreject the presentChallenger
Selecting the current bestChallenger could be risky if1) high cost and/or 2) longeconomic life 0 1 2 3 4
Year
EUACatEcono
micLife
PresentChallenger
Uniform Decline
Rapid ImprovementsIn Technology
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Ordinary taxes Gains and losses due to asset disposal
After-Tax Replacement Analysis
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Example 13-9Marginal Costs on After-Tax Basis
YearMarketValue
BookValue
RecapturedDepr. or
Loss Tax
After-TaxMarketValue
0 $25,000 $25,000 $25,000
118,000
20,000 -$2,000 -$800 18,8002 13,000 15,000 -2,000 -800 13,8003 9,000 10,000 -1,000 -400 9,4004 6,000 5,000 1,000 400 5,6005 4,000 4,000 1,600 2,400
6 3,000 3,000 1,200 1,8007 2,500 2,500 1,000 1,500
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Example 13-9Marginal Costs on After-Tax Basis
Year
After-Tax
MarketValue
CapitalRecovery
O&M+Ins.
TaxableIncome Tax
After-TaxMarginal
Cost
0 $25,0001 18,800 $8,700 $7,000 -$12,000 -$4,800 $10,9002 13,800 6,880 7,500 -12,500 -5,000 9,3803 9,400 5,780 8,000 -13,000 -5,200 8,5804 5,600 4,740 10,000 -15,000 -6,000 8,740
5 2,400 3,760 12,000 -17,000 -6,800 8,9606 1,800 840 14,000 -14,000 -5,600 9,2407 1,500 480 16,000 -16,000 -6,400 10,080
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Example 13-10After-Tax Minimum Cost Life
YearMarketValue
MACRSDepr.
BookValue
RecapturedDepr. or
Loss Tax
After-TaxMarketValue
0 $100,000 $100,000 $100,0001 50,000 $14,290 85,710 -$35,710 -$14,284 64,284
2 45,000 24,490 61,220 -16,220 -6,488 51,4883 40,000 17,490 43,730 -3,730 -1,492 41,4924 35,000 12,490 31,240 3,760 1,504 33,4965 30,000 8,930 22,310 7,690 3,076 26,9246 25,000 8,920 13,390 11,610 4,644 20,356
7 20,000 8,930 4,460 15,540 6,216 13,7848 15,000 4,460 0 15,000 6,000 9,0009 10,000 0 10,000 4,000 6,000
10 5,000 0 5,000 2,000 3,000
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Example 13-10After-Tax Minimum Cost Life
Yr.
After-taxMarketValue
CapitalRecovery O&M
TaxableIncome Tax
After-TaxMarginal
Cost EUAC0 $100,0001 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 290183 41,492 13,085 18,000 -35,490 -14,196 16,889 252084 33,496 10,486 22,000 -34,490 -13,796 18,690 237185 26,924 8,582 26,000 -34,930 -13,972 20,610 231676 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 232708 9,000 5,611 38,000 -42,460 -16,984 26,627 236109 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
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Example 13-11Before-Tax Minimum Cost Life
)N%,8,FA)(250MV()N%,8,PA)(400999,19(CR NN
)N%,8,PA]()j%,8,FP()M&O([)M&O(EUACN
1j
jN