Replacement Analysis

1
Chapter 11

• Replacement Analysis

2
Replacement Analysis

• Replacement analysis in needed for the following
  reasons
• Reduced Performance It results in increased
  costs (reliability, productivity).
• Altered requirements New features (speed,
  accuracy, etc).
• Obsolescence New products and developments.

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Terminology

• Defender The existing alternative.
• Challenger The new alternative.
• AW/EUAC values Annual Worth/Equivalent Uniform
  Annual Cost is used an a major measure for
  comparison.
• Economic Service Life (ESL) Number of years at
  which the lowest AW of costs occurred.
• Consultants Viewpoint (Outsider) Neither
  alternative is owned and the defender can be
  purchased in the market.

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Economic Service Life (ESL)

• By definition, is the number of years at which
  the equivalent annual worth (AW) or annual
  operating cost (AOC) is minimum.
• Determine the AW over n years and then find the
  smallest AW/AOC.

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Example

• An engineer calculated the AW values shown for a
  presently
• owned machine, using estimates she obtained from
  the vendor
• and company records.
• Retention Period, Years AW Value, /Year
• 1
  -92,999
• 2
  -81,000
• 3
  -87,000
• 4
  -89,000
• 5
  -95,000
• A challenger has an economic service life of 7
  years with an AW
• of -86,000 per year. Assuming all future costs
  remain as
• estimated for the analysis, when should the
  company purchase
• the challenger, if the MARR is 25 per year?

6
Example

• A challenger asset has a first cost of 70,000,
  an estimated annual operating cost of 20,000, a
  maximum useful life of 5 years, and a 10,000
  salvage value anytime it is replaced. At an
  interest rate of 20 per year, determine its
  economic service life and corresponding AW value.

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Solution

• n AW
• 1 -94,000
• 2 -61,273
• 3 -50,484
• 4 -45,177
• 5 -42,063
• N1
• AW -70,000(A/P,20,1) -20,000
• 10,000(A/F,20,1)
• -70,000(1.2) -20,000 10,000(1.000)
• - 94,000

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Solution

• n2
• AW -70,000(A/P,20,2) -20,000
• 10,000(A/F,20,2)
• -70,000(0.65455) 20,000
• 10,000 (0.45455)
• -61,273

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Replacement Study
No study period specified
Study period specified
Perform ESL analysis
Develop succession options for D and C using AWD
and AWC
PW or AW for each option
AWD
AWC
10
Example

• A pulp and paper company is evaluating whether it
  should retain
• the current bleaching process which uses chlorine
  dioxide or
• replace it with a proprietary oxypure process.
  The relevant costs
• for each process are shown. Use the interest rate
  of 20 per
• year.
• Cost
  Current Oxypure
• Original cost 8 years ago, -450,000
  -700,000
• Current market value, 25,000 -
• Annual operating cost,/year -160,000 -70,000
• Life, years 5
  10
• Salvage value, 0
  50,000
• Perform the replacement analysis.
• If equipment used in the current process can be
  sold intentionally, what is the minimum resale
  price needed to make the challenger replacement
  choice now?

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Solution

• AWD -25,000 (A/P,20,5) 160,000
• -25,000 (0.33438) 160,000
• -168,360
• AWC -700,000 (A/P,20,10) -70,000
• 50,000(A/F,20,10)
• -700,000(0.23852) -70,000
• 50,000(0.03852)
• -235,038
• Keep the current process for five years.

12
Solution

• B)
• RV(A/P,20,5) -160,000 700,000 (A/P,20,10)
  -70,000
• 
  50,000(A/F,20,10)
• -0.33438 RV-700,000(0.23852)70,000160,00050,00
  0(0.003552)
• RV 224,409