Currently making a profit equipment is operational

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Currently making a profit Equipment is operational Risks associated with change Decision to change is a future commitment Limited investment capital Uncertainty regarding future Psychological impact of sunk costs Technological improvement trap Prefer to be a “technology follower” Taking a “financial hit” on financial statements by writing off assets not fully depreciated
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Principles of Engineering Economic Analysis , 5th edition Make investments that are economically justified “If you need a new machine and don’t buy it, you pay for it without ever getting it.” Henry Ford
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Principles of Engineering Economic Analysis , 5th edition Principal Reason for Replacing an Asset: Obsolescence Functional obsolescence Technological obsolescence Economic obsolescence
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Principles of Engineering Economic Analysis , 5th edition Replacement Analysis Replacement Analysis Two approaches are commonly used in replacement analyses: the cash flow approach or insider approach and the opportunity cost approach or outsider viewpoint approach . If performed correctly, the two approaches will yield the same recommendation. (The essential difference in the two relates to how the salvage value of the defender is treated.)
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Principles of Engineering Economic Analysis , 5th edition Cash Flow Approach Before-Tax Analysis
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Principles of Engineering Economic Analysis , 5th edition Cash Flow Approach The cash flow approach can be called the insider viewpoint approach . The cash flows used are those that are “seen” by the internal decision maker in answer to the question, “how much money will be spent and how much will be received if I adopt this alternative?” In sum, we are interested in knowing how much money will be spent and received/saved if the asset is replaced and how much money will be spent and received/saved if it is retained.
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Principles of Engineering Economic Analysis , 5th edition Cash Flow Approach Cash Flow Approach Treat the proceeds from sale of the old machine as down payment toward purchasing the new machine. This approach is meaningful when both the defender and challenger have the same service life .
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Principles of Engineering Economic Analysis , 5th edition Example Defender Market price: $10,000 Remaining useful life: 3 years Salvage value: $2,500 Annual O&M cost: $8,000 Challenger Cost: $15,000 Useful life: 3 years Salvage value: $5,500 Annual O&M cost: $6,000
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Principles of Engineering Economic Analysis , 5th edition 0 1 2 3 0 1 2 3 $8000 $2500 $15,000 $6000 $5500 (a) Defender (b) Challenger $10,000 Sales proceeds from defender Replacement Analysis – Cash Flow Approach
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Principles of Engineering Economic Analysis , 5th edition Example 11.1 A surface mount placement machine was acquired 10 years ago for $300,000. It can be kept for a maximum of 5 more years, at which time it will have a negligible salvage value.
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  • Fall '17
  • Mike Heny
  • Economics, Generally Accepted Accounting Principles, Replacements

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