Chapter 11 Replacement & Retention Modified

Chapter 11
Replacement & Retention
• Reasons for replacement

• The Basics of replacement terminology
• Economic Service Life
• Replacement Study
• Replacement Study (a Specified Study Period)
Reasons for replacement
1. Reduced performance
2. Altered requirements
3. Obsolescence
The Basics of replacement terminology
• Defender
• Challenger
• Sunk cost
• Market value (MV)
• Trade-in Value
• Insider’s Viewpoint / Outsider’s Viewpoint (at year 0):
• Defender first cost
• Challenger first cost
• Economic service life
Economic Service Life
$
Total Annual Cost
Annual O & M Cost
Capital Recovery Cost
Life, years
Economic Service Life - Example
Determine the ESL of an asset which has the costs 10 K
shown below. Let i = 10% 8K
5K 5K 3K
Year Cost,$/year Salvage value,$
0 1 2 3 4 5
0 - 20,000 -
1 -5,000 10,000
2 -6,500 8,000 5K 6.5 K 9K 11 K
3 - 9,000 5,000 15 K
4 -11,000 5,000 P = 20 K
5 -15,000 3,000
AW1 (10%) = { 20 K + 5 K (P/F,10%,1) } (A/P,10%,1) – 10 K (A/F,10%,1) = $ 17 K

AW2 (10%) = { 20 K + 5 K (P/F,10%,1) + 6.5 K (P/F 10%, 2)} (A/P,10%, 2) – 8 K (A/F,10%, 2) = $ 13.43 K
AW3 (10%) = { 20 K + 5 K (P/F,10%,1) + 6.5 K (P/F 10%, 2) + 9 K (P/F 10%, 3) } (A/P,10%,3) – 5 K (A/F,10%, 3) = $ 13.24 K
AW4 (10%) = { 20 K + 5 K (P/F,10%,1) + 6.5 K (P/F 10%, 2) + 9 K (P/F 10%, 3) + 11 K (P/F 10%, 4) } (A/P,10% ,4) – 5 K (A/F,10%, 4) = $ 12.86 K ESL
AW5 (10%) = { 20 K + 5 K (P/F,10%,1) + 6.5 K (P/F 10%, 2) + 9 K (P/F 10%, 3) + 11 K (P/F 10%, 4) + 15 K (P/F 10%, 5) } (A/P,10% ,5) – 3 K (A/F,10%, 5)
= $ 13.62 K
Replacement Study- Example
11.22 Three years ago, Witt Gas Controls purchased equipment for $80,000 that was expected to have a useful
life of 5 years with a $9000 salvage value. Increased demand necessitated an upgrade costing $30,000 one year
ago. Technology changes now require that the equipment be upgraded again for another $25,000 so that it can be
used for 3 more years. Its annual operating cost will be $47,000, and it will have a $22,000 salvage after 3 years.
Alternatively, it can be replaced with new equipment that will cost $68,000 with operating costs of $35,000 per
year and a salvage value of $21,000 after 3 years. If replaced now, the existing equipment will be sold for
$9000. Perform the replacement study at an interest rate of 10% per year.
22 K
-3 -2 -1 0 1 2 3
Defender Sunk Costs 9K

25 K
30 K
80 K A = 47 K
21 K
0 1 2 3
Challenger
68 K A = 35 K
22 K
Outsider Viewpoint: Defender 0 1 2 3
9K
25 K
A = 47 K
AWD (10%) = ( 25 K + 9 K) (A/P 10%, 3) + 47 K - 22 K (A/F 10%, 3)
0.4021 0.3021
= 54.03 K/year Retain/Keep defender 21 K

0 1 2 3
Challenger
A = 35 K
68 K
AWC (10%) = 68 K (A/P 10%, 3) + 35 K - 21 K (A/F 10%, 3) = 56.0 K/year

22 K
Insider Viewpoint: Defender 0 1 2 3
9K
25 K
A = 47 K
AWD (10%) = 25 K (A/P 10%, 3) + 47 K - 22 K (A/F 10%, 3)
= 0.4021 0.3021
= 50.41 K/year Retain/Keep defender
21 K
9K
0 1 2 3
Challenger
A = 35 K
68 K
AWC (10%) = ( 68 K – 9 K ) (A/P 10%, 3) + 35 K - 21 K (A/F 10%, 3) = 52.38 K/year

Economic Service Life (a Specified Study Period) - Example
11. 35 ABB Communications is considering replacing equipment that had a first cost of
$300,000 five years ago. The company CEO wants to know if the equipment should be
replaced now or at any other time over the next 3 years to minimize the cost of producing
miniature background suppression sensors. Since the present equipment or the proposed
equipment can be used for any or all of the 3-year period, one of the company’s industrial
engineers produced AW cost information for the defender and challenger as shown below.
The values represent the annual costs of the respective equipment if used for the indicated
number of years. Determine when the defender should be replaced to minimize the cost to
ABB for the 3-year study period using an interest rate of 10% per year.
AW If kept stated Number of Years, $ per Year

Number of Years Kept
Defender Challenger
1 22,000 29,000
2 24,000 26,000
3 27,000 25,000
4 Possibilities: 0 1 2 3
Possibility 1
Possibility
1 D D D
A = 27 K
2 D D C
0 1 2 3
3 D C C Possibility 2
4 C C C
A = 24 K
29 K
AW If kept stated Number of
Number of Years, $ per Year 0 1 2 3
Possibility 3
Years Kept
Defender Challenger
1 22,000 29,000
22 K
A = 26 K
2 24,000 26,000 0 1 2 3
Possibility 4
3 27,000 25,000
A = 25 K
0 1 2 3
1
PW1 (10%) = 27 K (P/A 10%, 3) = 67.15 K
2.4869
A = 27 K
PW2 (10%) = 24 K (P/A 10%, 2) + 29 K (P/F 10%, 3)
1.7355 0.7513 0 1 2 3
2
= 63.44 K
A = 24 K
29 K
PW3 (10%) = { 22 K+ 26 K (P/A 10%, 2) } (P/F 10%, 1) 0 1 2 3
0.9091 1.7355 3
= 61.02 K The Best Cost
22 K
A = 26 K
4 0 1 2 3
PW4 (10%) = 25 K (P/A 10%, 3) = 62.17 K
2.4869
A = 25 K
Chapter 11 Problems:
• Economic Service Life: 8 – 18 8, 12, & 15
• Replacement Study: 19 – 34 22 & 24

• Replacement Study
(a Specified Study Period): 35 – 42 35 & 36

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Chapter 11

Replacement & Retention

• Reasons for replacement

Annual O & M Cost

Capital Recovery Cost

AW1 (10%) = { 20 K + 5 K (P/F,10%,1) } (A/P,10%,1) – 10 K (A/F,10%,1) = $ 17 K

Defender Sunk Costs 9K

Outsider Viewpoint: Defender 0 1 2 3

= 54.03 K/year Retain/Keep defender 21 K

AWC (10%) = 68 K (A/P 10%, 3) + 35 K - 21 K (A/F 10%, 3) = 56.0 K/year

AWC (10%) = ( 68 K – 9 K ) (A/P 10%, 3) + 35 K - 21 K (A/F 10%, 3) = 52.38 K/year

AW If kept stated Number of Years, $ per Year

• Economic Service Life: 8 – 18 8, 12, & 15

• Replacement Study: 19 – 34 22 & 24

(a Speciﬁed Study Period): 35 – 42 35 & 36

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