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NEW VISION OF ENGINEERING ECONOMY COURSE VISION MODULE 3

JULY 2005 . TEI OF PIRAEUS. 2. 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.

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NEW VISION OF ENGINEERING ECONOMY COURSE VISION MODULE 3

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    1. NEW VISION OF ENGINEERING ECONOMY COURSE (VISION) MODULE 3 LECTURE 5: Replacement Analysis

    2. JULY 2005 TEI OF PIRAEUS 2 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 >= EL.

    3. JULY 2005 TEI OF PIRAEUS 3 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

    4. JULY 2005 TEI OF PIRAEUS 4 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)

    5. JULY 2005 TEI OF PIRAEUS 5 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.

    6. JULY 2005 TEI OF PIRAEUS 6 Example Use the data below to make recommendations related to the replacement of Equipment A with Equipment B.

    7. JULY 2005 TEI OF PIRAEUS 7 Example (cont.) Assuming straight line depreciation, the annual expenses with Equipment B = 50,000+1,000,000/10= 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.

    8. JULY 2005 TEI OF PIRAEUS 8 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.

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