NEW VISION OF ENGINEERING ECONOMY COURSE (VISION) MODULE 3

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NEW VISION OF ENGINEERING ECONOMY COURSE (VISION)
MODULE 3

• LECTURE 5 Replacement Analysis

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Scope

• Replacement analysis is concerned with the
  question When is it time to replace an existing
  piece of equipment with a new one?
• Physical life (PL) is different from economic
  life (EL).
• Economic life is the time after which we save
  money by replacing the asset.
• Thus, PL gt EL.

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Various cases of replacement

• No Replacement of an existing asset (getting rid
  of it)
• Replacement of an asset with another identical
  asset
• Replacement of an asset with another not
  identical asset
• The basis for comparison is the Equivalent
  Uniform Annual Cost

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Annual Cost Estimation

• It includes the initial cost of the asset over
  its life (taking into account for the salvage
  value of the asset)
• and the annual costs of repairs and maintenance
  (including any costs of correcting defects in the
  product)

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Common Errors in Replacement Analysis

• They are caused by failure to realise that a
  replacement analysis must be based on conditions
  existing at the present time.
• The unamortised value of the property must not be
  added to the replacement investment. Instead it
  should be completely ignored.

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Example

• Use the data below to make recommendations
  related to the replacement of Equipment A with
  Equipment B.

EQUIPMENT A EQUIPMENT B
Capital Investment () 2,000,000 1,000,000
Estimated Economic Life 10 10
Residual Value 0 0
Annual Cash Expenses () 250,000 250,000
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Example (cont.)

• Assuming straight line depreciation, the annual
  expenses with Equipment B 50,0001,000,000/10
  150,000
• For replacement economic comparison, Equipment A
  worths nothing at the present time therefore,
  the annual total expenses with Equipment A are
  250,000.
• The investment of 2,000,000 of Equipment A is
  completely lost if Equipment B is installed.

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Example (cont.)

• Thus, the total necessary investment to make an
  annual saving of 250,000-150,000 100,000 is
  1,000,000.
• Therefore, the Return on Investment is 10. If
  this is acceptable, then the replacement should
  be made.