Chapter 12 - Replacement Click here for Streaming Audio To Accompany Presentation (optional)EGR 403 - The Big PictureReplacement AnalysisReplacement Analysis TermsAspects of Replacement AnalysisThe Replacement ProblemIssues (Consider Before Starting)Issues (Continued)Slide 9Replacement Analysis Decision ChartWhat Is the Basic Comparison?Minimum Cost Life of the ChallengerSlide 13Slide 14Marginal CostsSlide 16Marginal Cost Data DefenderReplacement Analysis Technique #1Analysis Technique # 1Relaxing the RestrictionsReplacement Analysis Technique #2Replacement Analysis Technique #3After Tax Replacement AnalysisChapter 12 - Replacement Click here for Streaming Audio To Accompany Presentation (optional)EGR 403 Capital Allocation TheoryDr. Phillip R. RosenkrantzIndustrial & Manufacturing Engineering DepartmentCal Poly PomonaEGR 403 - Cal Poly Pomona - SA15 2EGR 403 - The Big Picture•Framework: Accounting & Breakeven Analysis•“Time-value of money” concepts - Ch. 3, 4•Analysis methods–Ch. 5 - Present Worth–Ch. 6 - Annual Worth–Ch. 7,7A,8 - Rate of Return (incremental analysis)–Ch. 9 - Benefit Cost Ratio & other methods•Refining the analysis–Ch. 10, 11 - Depreciation & Taxes–Ch. 12 - Replacement AnalysisEGR 403 - Cal Poly Pomona - SA15 3Replacement Analysis•When should a new truck replace the existing truck?•When should a process be redesigned?•When should a product be redesigned?The most common question asked in industry is when should the existing be replaced?EGR 403 - Cal Poly Pomona - SA15 4Replacement Analysis Terms•Defender - the existing equipment or building previously implemented.•Challenger - the proposed replacement currently under consideration.EGR 403 - Cal Poly Pomona - SA15 5Aspects of Replacement Analysis•Using available data to determine the analysis technique.•Determining the base comparison between alternatives.•Using analysis techniques when: •Defender marginal cost can be computed and is increasing.•Defender marginal cost can be computed and is not increasing.•Defender marginal cost is not available.•Considering possible future challengers.•After-tax analysis.EGR 403 - Cal Poly Pomona - SA15 6The Replacement Problem•Engineers replace the existing due to:–Obsolescence - technological change.–Depletion - loss of market value.–Deterioration - wear that is overly expensive to repair.Shall the defender be replaced now or be maintained for one or more periods.EGR 403 - Cal Poly Pomona - SA15 7Issues (Consider Before Starting)•Is it morally or ethically right to do this project?•If a unit fails, must it be removed permanently from service? Or repaired? Are standby units available if the system should fail?•Do components or units fail independently of the failure of other components?•Is there a budget constraint?•In the event that the unit can be repaired after failure is their a constraint on the capacity of the repair facility?EGR 403 - Cal Poly Pomona - SA15 8Issues (Continued)•Is there only one replacement allowed over the planning horizon? Are subsequent replacements allowed at any time during the study period?• Is their more than one replacement unit (price and quality combination) available at a given point in time?•Do future replacement units differ over time? Are technological improvements considered?•Is preventative maintenance included in the model?EGR 403 - Cal Poly Pomona - SA15 9Issues (Continued)•Are periodic operating and maintenance costs constant or variable over time?•Is the planning horizon finite or infinite?•Are consequences other than economic impacts, i.e., sociotechnical issues considered?•Are income tax consequences considered?•Is “inflation” considered?•Does replacement occur simultaneously with retirement, or are there nonzero lead times?•Are cash flow estimates deterministic or stochastic?EGR 403 - Cal Poly Pomona - SA15 10Replacement Analysis Decision ChartCompareWhereNot increasingIncreasingDefender Marginal CostNot availableAvailableAvailableDefender Marginal CostEUAC at Minimum Cost LifeEUAC over Remaining Useful Life3EUAC at Minimum Cost LifeEUAC at Minimum Cost Life2EUAC at Minimum Cost LifeNext-year Marginal Cost1Best ChallengerDefenderAnalysis TechniquesEGR 403 - Cal Poly Pomona - SA15 11What Is the Basic Comparison?•Identify the defender and the best challenger.–Product.–Machine.–Process.–Personnel.–Mix.Decision Criteria leads to one of the following:If the defender is more economical, it should be retained.If the challenger is more economical, it should be installed.EGR 403 - Cal Poly Pomona - SA15 12Minimum Cost Life of the Challenger• Calculate the EUAC for each value of the useful life (e.g., n = 1, n = 2, n = 3, etc.)• The number of years at which the EUAC is minimized is the minimum cost life (economic useful life)• Consider Example 12 - 1–$7500 initial cost (P)–$900 arithmetic gradient maintenance cost (G)–$500 uniform cost (A) and 400 arithmetic gradient operating cost (G)EGR 403 - Cal Poly Pomona - SA15 13YearEUAC of Capital Recovery CostsEUAC of Maintenance and Repair CostsEUAC of Operating CostsEUAC TotalInterest rateInitial year -7500 0 -500Arithmetic gradient-900 -4001 $8,100.00 $0.00 $500.00 $8,600.00 2 $4,205.77 $432.69 $692.31 $5,330.77 3 $2,910.25 $853.87 $879.50 $4,643.62 4 $2,264.41 $1,263.56 $1,061.58 $4,589.55 <-----MIN5 $1,878.42 $1,661.82 $1,238.59 $4,778.84 6 $1,622.37 $2,048.71 $1,410.54 $5,081.62 7 $1,440.54 $2,424.30 $1,577.47 $5,442.31 8 $1,305.11 $2,788.67 $1,739.41 $5,833.19 9 $1,200.60 $3,141.93 $1,896.41 $6,238.94 10 $1,117.72 $3,484.18 $2,048.53 $6,650.43 11 $1,050.57 $3,815.55 $2,195.80 $7,061.93 12 $995.21 $4,136.17 $2,338.30 $7,469.68 13 $948.91 $4,446.19 $2,476.08 $7,871.18 14 $909.73 $4,745.75 $2,609.22 $8,264.69 15 $876.22 $5,035.01 $2,737.78 $8,649.02 8%EUAC calculations for increasing values of useful lifeEGR 403 - Cal Poly Pomona - SA15 14Graph of EUAC by n.Economic Useful Life is where Total EUAC is minimizedEGR 403 - Cal Poly Pomona - SA15 15Marginal Costs•Marginal Costs are the year by year costs for keeping an asset. Example 12-2 illustrates the calculation of the marginal costs for a new item.•Marginal Cost includes:–Loss in value of the asset by retaining it for one more year–Lost interest on the money tied up in the asset–Costs and expenses directly related to the project or asset (e.g.,
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