Lec%2038 - IE 343 Engineering Economics Lecture 38 Chapter...

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IE 343 Engineering Economics Lecture 38: Chapter 9 – Replacement Analysis Instructor: Tian Ni Dec.2, 2011 IE 343 Fall 2011 1
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Retirement without Replacement (Abandonment) IE 343 Fall 2011 2
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IE 343 Fall 2011 When to retire an asset Consider a project for which the period of required service is finite and that has positive net cash flows following an initial capital investment . Market values , or abandonment values , are estimated for the end of each remaining year in the project’s year In view of an opportunity cost (MARR) of i% per year, should the project be undertaken? In other words, what is the economic life of the project? 3
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IE 343 Fall 2011 Retirement without Replacement Two Key Assumptions: 1. Once a capital investment has been made, the firm desires to postpone the decision to abandon a project as long as its present equivalent value(PW) is not decreasing 2. The existing project will be terminated at the best abandonment time and will not be replaced by the firm 4
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IE 343 Fall 2011 Retirement without Replacement Rule of finding abandonment time: Abandonment time is year of max PW 5
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IE 343 Fall 2011 Example 9.9 An $80,000 baling machine for recycled paper was purchased by the XYZ company two years ago. The current MV of the machine is $50,000, and it can be kept in service for seven more years. MARR is 12% per year and the projected net annual receipts (revenues less expenses) and end-of-year market values for the machine are shown on the table. When is the best time for the company to abandon this project? 6
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IE 343 Fall 2011 Example 9.9 End of Year 1 2 3 4 5 6 7 Net Annual Receipts 20,000 20,000 18,000 15,000 12,000 6,000 3,000 Market Value 40,000 32,000 25,000 20,000 15,000 10,000 5,000 7
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IE 343 Fall 2011 Example 9.9 – Solution Use the PWs that result from deciding to keep the machine exactly one, two, three, four, five, six, and seven years: Keep for one year: PW 1 (12%) = -$50,000 + ($20,000 + $40,000)(P/F, 12%, 1) = $3,571 Keep for two year: PW 2 (12%) = -$50,000 + $20,000(P/F, 12%, 1) + ($20,000 + $32,000)(P/F, 12%, 2) = $3,571 8
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IE 343 Fall 2011 Example 9.9 – Solution Keep for three year: PW 3 (12%) = $14,408 Keep for four year: PW 4 (12%) = $18,856 Keep for five year: PW 5 (12%) = $21,466 Keep for six year: PW 6 (12%) = $21,061 Keep for seven year: PW 7 (12%) = $19,614 Solution : FIVE years maximizes the PW, so keep the machine for FIVE years. 9
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After-Tax Replacement Studies IE 343 Fall 2011 10
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IE 343 Fall 2011 After-Tax Replacement Studies Income taxes associated with a proposed project may represent a major cash outflow for a firm Taxes have significant effects on cash flows In replacement studies, the replacement of an asset often results in gains or losses from the sale of the existing asset(Defender).
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