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ENGR 3360U Winter 2014

Unit 13

Replacement Decisions

Dr. J. Michael Bennett, P. Eng., PMP,

UOIT,

Version 2014-I-01

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Unit 13 Replacement Studies

Chane Record

2014!"!01 "nitial Creation

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Course 'utline

1# Enineerin Economics

2# General Economics

1# %icroeconomics

2# %acroeconomics

3# %one( and the &an) o*Canada

3# Enineerin Estimation

4# "nterest and E+ui,alence

-# .resent Worth /nal(sis

6# /nnual Cash lo

# Rate o* Return /nal(sis

# .ic)in the &est Choice

# 'ther Choosin 5echni+ues

10# Uncertaint( and Ris)

11# "ncome and Depreciation

12# /*ter!ta Cash los

13# Replacement /nal(sis

14# "n*lation1-# %/RR Selection

16# .u7lic Sector "ssues

1# What Enineerin should )no

a7out /ccountin

1# .ersonal Economics *or the

Enineer

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8inear Estimation Rule


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Unit 13 Road %ap

13#1 &asics

13#2 Economic Ser,ice 8i*e

13#3 Replacement Stud(

13#4 /dditional Considerations

13#- Stud( .eriod

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13#1 &asics o* Replacement Stud(

Reduced .er*ormance9Wear and tear

Decreasin relia7ilit( and producti,it(

"ncreasin operatin and maintenance costs

/ltered Re+uirements9

Ne production needs: accurac(: speed: etc#

'7solescence9

Current assets ma( 7e less producti,e

Not state o* the art ; need to meet competition

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2014!"!01 Dr# $#%# &ennett ENGR 3360 Winter 201213!

5erminolo( De*ender /sset9

Currentl( installed asset<

Challener /sset9

5he potential replacement or =challenin> asset<

Under consideration to replace the de*ender asset#

5oether: De*ender ?D@ and Challener ?C@

Constitute mutuall( eclusi,e alternati,es<

Select one and reAect the other #

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5erminolo( ! continued

/W ,alues are t(picall( calculatedEU/C ;E+ui,alent Uni*orm /nnual Cost

"ncludes mostl( costs estimates

Economic Ser,ice 8i*e ?ES8@

or a i,en alternati,e is9

Num7er o* (ears at hich the loest /W!o*!cost occurs

De*ender irst Cost

"nitial in,estment in the de*ender ; .

Current %ar)et ,alue no ; correct estimate to assin to

)eepin a de*ender

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5erminolo( ! continued Challener *irst cost

/mount o* capital that must 7e reco,ered hen replacin a

de*ender ith a challener

Sun) cost

Cost that has occurred in the past and cannot 7e altered

Sun) costs are enerall( o* no use in a 7e*ore!ta

replacement anal(sis

ConsultantBs ,iepoint

5he anal(st assumes that heshe is an outsider ?a consultant@5hus: the anal(st ons neither asset and must assin

reasona7le ,alue to the de*ender and challener

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5he .roper iepoint

or a replacement anal(sis to in,estment costsare critical9

1# 5he proper in,estment cost to appl( to

)eepin the de*ender in ser,ice<

2# 5he proper in,estment cost to appl( to an(

challener asset that miht replace the

current de*ender asset#While it may seem strange to charge an investment cost for keeping one’s ownasset (the defender) this is what must occur. Keeping the defender is not free!

Why?

&ecause the *irm is i,in up the opportunit( to recei,e a possi7le cash *lo

*rom sellin the current de*ender#

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"n,estment Concerns

'ne must assin an in,estment cost to EE."NG thede*ender asset

5he appropriate in,estment cost to assin to the de*ender

asset is9

5he current *air mar)et ,alue o* the de*ender at thetime the replacement decision is 7ein eamined#

Challener "n,estment

5his is the total in,estment ?.challener @ re+uired *or a ne?challener@ asset that ill possi7l( replace the current de*ender#

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13#2 Economic Ser,ice 8i*e ?ES8@?%inimum Cost 8i*e@

ES8 is9 Num7er o* (ears n at hich the e+ui,alent annual orth?/W@ o* costs is minimiFed considerin the most currentcost estimates o,er all possi7le (ears that the asset ma(

pro,ide a needed ser,ice ES8 is the n here total /W is a minimum *orta7ulation at i o,er a selected rane o* (ears#

.lot n ,ersus

5otal /W H ; CR ; /W o* annual operatin costs

See) the time period that minimiFes the 5otal /W *or the rane o*li,es selected

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5(pical /nnual Worth .lot

Represents the n *or

Economic Ser,ice 8i*e

Seek the n

value

resulting in

minimum

otal W

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Replacement Decision %ap

I '*ten the +uestion is not if 7ut when shouldan asset 7( replaced#


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2014!"!01 Dr# $#%# &ennett ENGR 3360 Winter 201213!1-

5a7ulatin the 5otal /W o* Costs

Note the *olloin Capital reco,er( costs decline as time

increases

/W o* costs increase o,er time

5otal /W H ! CR ! /Wcosts

See pre,ious *iure and e+uation

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Challener ,s De*ender

/s lon as the marinal ?(earl(@ cost o* thede*ender is 8ESS than the EU/C o* the

challener: retain the de*ender#


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Eample 13#3

/n asset purchased - (ears ao *or J- is no orthJ1-# 'peratin epenses ill 7e J10 this (ear 7utill increase 7( J1#- per (ear# 5he %ar)et alue illdecrease 7( J1 per (ear o,er the net - (ears# "* the%/RR is 1-: calculate the marinal cost o*onership o* the asset#

i 13 l S di

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Solution

Kear 8oss in% "nt 'C %arC

1 !1 1-?#1-@H22-0 10 13:2-0

2 !1 14?#1-@H2100 11#- 14:600

3 !1 13?#1-@H1-0 13 1-:-0

4 !1 12?#1-@H100 14#- 1:300

- !1 11?#1-@H16-0 16 1:6-0


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"mportant .oints

%arinal costs ?%C@ are (ear!7(!(earestimates o* the costs to on and operate an

asset *or one (ear

/W o* marinal costs H total /W o* costs

5he anal(sis is 7est per*ormed ,ia a

spreadsheet model

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13#3 .er*ormin a EU/C Replacement Stud(

5o approaches9

1# Without a stud( period

2# With a stud( period

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Ne Replacement Stud(

Gi,en9 ?C@ and ?D@ estimates: select one /ppl(9

/WD ,s# /WC

Select the 7etter alternati,e

Sta( ith the De*ender *or nD (ears or:

Go ith the challener *or nC (ears#

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'ne!Kear 8ater /nal(sis alidate all cost and mar)et ,alue estimates<

"* estimates are still ood: is the current (ear nDL

"* =KES>: replace ?D@ ith ?C@<

"* =N'>: retain de*ender *or one more (ear and

re!e,aluate then#

"* cost estimates ha,e chaned then9

Update all estimates

Calculate /WC and /WD

"nitiate a ne replacement stud(

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%ar)et alue o* De*ender

What minimum market value o* the de*enderill ma)e the current challener economicall(

attracti,eL

"* a hih enouh mar)et ,alue ?trade!in@ is possi7le *or the de*ender asset: one should ta)e

it and o ith the challener immediatel(M

&rea)!e,en or replacement value ?R@If the actual market value (trade-in) exceed the breakeven

replacement value, the challenger is the better alternative.

If this is the case, replace now with the challenger!

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13#4 /dditional Considerations in a

Replacement Stud(

Se,eral additional aspects o* a replacement stud(

1#uture!(ear replacement decisions<

2# 'pportunit( cost ,s# Cash *lo approaches<

3# /nticipation o* impro,ed *uture challeners#

5he anal(st must understand trends: ad,ances: chanes intechnolo(: and competiti,e pressures that o*ten impact the

remainin li*e o* a de*ender and the challener


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2014!"!01 Dr# $#%# &ennett ENGR 3360 Winter 201213!2-

uture Replacement Decisions

1# uture!(ear replacement decisions9Replace noL 'ne (ear *rom noL 5o

(ears *rom noL etc#

5he procedure Aust presented does assist

ith anserin this +uestion pro,ided9

5he cost estimates *or ?C@ and ?D@ do not

chane#


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uture Replacement Decisions

1# uture!(ear replacement decisions9"* cost estimates chane *or either ?D@ or

?C@ then the anal(sis should 7e initiated

aain ithin a reasona7le time *rame#

With chanin estimates the decision to

replace ma( 7e altered


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2# 'pportunit( Cost ,s# Cash lo

'pportunit( cost approach5he method Aust presented applies the opportunit(

cost approach9

"n,estment in D no is the *air mar)et ,alue o* D no<

Represents the opportunit( cost *oreone 7( not

disposin o* D no<

"n,estment in C no is the *irst cost o* C

5his is a correct approach *or areplacement anal(sis#


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Cash lo /pproach

Cash lo /pproach/ssumes that hen the challener is selected and

the de*ender trade!in is a cash in*lo: then9

5he in,estment in the challener isimmediatel( reduced 7( the trade!in amount#

Discourae this approach<

Wor)s onl( i* the li,es o* C and D aree+ualM


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/nticipation o* uture Challeners

3# /ssumption9 /t some time in the *uture aorth( challener ill appear and replace

the de*ender#

/la(s stud( *uture trends o* challeners<%a( 7e 7est to aument the de*ender until

such time that a more orth( challener

7ecomes a,aila7le#

5a considerations should 7e considered#


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13#- Speci*ied Stud( .eriod

/t times: a *ied stud( period ill appl( to 7oth the challener and de*ender#

Such a stud( ma( not 7e 7ased upon the

ES8 approach *or one or 7oth alternati,es#

"* a *ied stud( period then approach is


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Speci*ied Stud( .eriod

Determine /W *or 7oth C and D o,er the prescri7ed stud( period<

No need to per*orm an ES8 anal(sis<

/ssumption is that the ser,ices o* C and D

are not needed 7e(ond the stud( period#

Use the /W relations o,er the stud( period

to select C or D


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De*enderBs Remainin 8i*e

"* the de*enderBs remainin li*e is shorter than thestud( period

Focus on upgrading the defender and obtaincost estimates in order to extend the

defender out to the stud period.

hese costs become part of retaining the

defender out to the prescribed stud period

and are used in the replacement stud


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Chapter Summar(

Compare the 7est challener to the current de*ender<

=&est> is de*ined as the option ith the loest /W o*

costs o,er the speci*ied period o* time<

/ppl( the ES8 method to *ind the economic li*e o* thede*ender and challener<

or ES8: need estimates o* *uture mar)et ,alues and

annual operatin costs *or 7oth C and D# /W is the 7est method: especiall( i* alternati,e li,es are

une+ual#


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Summar( ! continued

or a *ied stud( period: appl( the traditional/W method *or 7oth D and C#

/la(s *ocus on the estimates o* *uture costs

and mar)et ,alues usin sound principles o*estimation#

/,oid the trap o* incorporatin sun) costs

into a replacement anal(sis

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