8-Replacement%20Analysis

8-Replacement%20Analysis - Engineering Economics ECO 1192...

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Engineering Economics ECO 1192 Lecture 8: Replacement Analysis Claude Théoret University of Ottawa
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ECO 1192A -- Fall 2009 Lecture 8: Fixed Asset Replacement Analysis 2 Recommended Reading Fraser et al.* chapter 7 Newnan et al. chapter 13 Park chapter 11
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ECO 1192A -- Fall 2009 Lecture 8: Fixed Asset Replacement Analysis 3 Lecture Objectives Analyze the timing of physical (fixed) asset replacement to minimize cost Cyclic Defender and challenger Examine two perspectives (points of view) on replacement issues Owner Consultant Applications Tax and non-tax
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ECO 1192A -- Fall 2009 Lecture 8: Fixed Asset Replacement Analysis 4 Introduction At some point, physical assets e.g., machinery and equipment Wear out Are inadequate to meet product demand Become obsolete (their services are no longer required) Consideration must be given to replacing the existing assets, the defender, with a new alternative called the challenger which may be An identical asset A newer model (usually with a higher first cost than the existing asset but with lower annual costs). The problem facing management is to determine the exact time (objective is to minimise costs) at which a more efficient asset (the challenger) should replace the existing equipment .
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ECO 1192A -- Fall 2009 Lecture 8: Fixed Asset Replacement Analysis 5 For this course The replacement timing of a capital (physical) asset will be based on key assumptions 1. With and without tax implications 2. No new challenger is expected during the economic life of the current challenger. 3. Planning or business horizon physical assets similar to the defender and the challenger are required for periods Shorter than the life of the defender and/or the challenger Longer than the life of the defender and/or the challenger
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ECO 1192A -- Fall 2009 Lecture 8: Fixed Asset Replacement Analysis 6 Why replace fixed assets? Physical impairment the existing asset is worn out because of normal use or accident and will no longer render its intended function unless extensive repairs are made Inadequacy the existing asset does not have sufficient capacity to fill the current and expected demands; to meet the new demands, the existing asset must be either supplemented or replaced .
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ECO 1192A -- Fall 2009 Lecture 8: Fixed Asset Replacement Analysis 7 Why replace fixed assets? (cont’d) Obsolescence functional : a decrease in the demand for the output of the asset a loss of revenue economic : the existence of a new asset with lower production costs than those of the existing asset Rental or lease possibilities variation of obsolescence except that the replacement asset does not necessarily have to be any different from the existing asset It may simply be more financially or fiscally advantageous.
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ECO 1192A -- Fall 2009 Lecture 8: Fixed Asset Replacement Analysis 8 Definitions of Asset Life 1. Economic - the period of time extending from the date of installation to the date of retirement (by demotion or disposal)
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