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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Authored by Don Smith, Texas A&M University 2004
CHAPTER 11
Replacement and RetentionDecisions
McGrawHill
ENGINEERING ECONOMYSixthEdition
Blank and
Tarquin
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Authored by Don Smith, Texas A&M University 2004
Chapter 11 Learning Objectives
1. Basics of Replacement Study;2. Economic Service Life;
3. Performing a Replacement Study;
4. Additional Considerations in aReplacement Study;
5. Replacement Study over aSpecified Study Period;
6. Chapter Summary
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Authored by Don Smith, Texas A&M University 2004
CHAPTER 11
Section 11.1 Basics ofReplacement Study
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Authored by Don Smith, Texas A&M University 2004
11.1 Why Replace Assets
Reduced Performance: Wear and Tear;
Decreasing reliability and Productivity;
Increasing operating and maintenance costs.
Altered Requirements: New production needs, accuracy, speed, etc.
Obsolescence:
Current assets may be less productive;
Not state of the art meet competition.
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Authored by Don Smith, Texas A&M University 2004
11.1 Terminology
Defender Asset:
Current installed asset;
Challenger Asset:
The potential replacement or challenging asset;
Under consideration to replace the defender asset.
Together, the Defender and Challenger:
Constitute mutually exclusive alternatives;
Select one and reject the other.
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Authored by Don Smith, Texas A&M University 2004
11.1 Annual Worth Values
Analysis Approach forReplacement:
Annual Worth Approach;
EUAC since costs tend todominate the study (-) cash
flows;
Salvage values if any are alsopart of the analysis (+) value.
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Authored by Don Smith, Texas A&M University 2004
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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Authored by Don Smith, Texas A&M University 2004
11.1 Investment Concerns-Defender
For a replacement analysis twoinvestment costs are critical:
1. The proper investment cost to
apply to keeping the defenderin service;
2. The proper investment cost to
apply to any challenger asset
that might replace the current
defender asset.
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Authored by Don Smith, Texas A&M University 2004
11.1 Investment Concerns-Defender
While it may seem strange tocharge an investment cost for
keeping ones 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 cashflow from selling the current defender!
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11.1 Investment Concerns
One must assign an investmentcost to KEEPING the defender
asset!
The appropriate investment costto 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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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
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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 theinvestment 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 thechallenger?
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11.1 Trade In Concerns
Often a trade in value is offered bya 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 issunk 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 ImportantQuestion
At times, a high trade-in valuemay 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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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
Authored by Don Smith, Texas A&M University 2004
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 thechallenger to the firm!
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Copyright The McGraw-Hill Companies, Inc. Permission required for reproduction or display.
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11.1 Trade-In Issues
Investment in the challenger
PC (TIV MVD)
The Cash pricefor
The challengerwith
No trade-in
The Opportunity CostGiven up by not
Selling theDefender outright!
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Copyright The McGraw Hill Companies, Inc. Permission required for reproduction or display.
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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!
T
