Question

Question 1 0/10 points In a replacement study, the correct value for the first cost of the defender is: a) the cost when it is purchased. b) the first cost minus the trade-in value of the defender. c) its first cost plus the trade-in value of the defender. d) the book value of the defender.

Answer 1

In a replacement study, the correct value for the first cost of the defender is:

a) the cost when it is purchased.

b) the first cost minus the trade-in value of the defender.

c) its first cost plus the trade-in value of the defender.

d) the book value of the defender

ans- b)

• Defender - Currently owned (in place) item.
• Challenger - The new possible replacement item /alternative.
• Outsider perspective - Analyst neither owns nor uses either the defender or challenger.

• Analysis uses EAC for comparison.
• First cost of (P) :
  • Defender P = Current market value (MV) . value of asset if sol on open market (EBay).
    • The owner foregoes this amount of capital; by not trading in the asset.
    • May add any current costs to P if upgrades are needed now to make asset worth keeping.
  • Challenger P = Acquisition cost of new asset
    • If the vendor offers a trade-in value (TIV) more than the MV for the defender Challenger P = P- (TIV - MV)
• The owner foregoes this amount of capital by not trading in the asset.
• Do not include "Sunk Costs" which are unrecoverable due to loss of value prior to the beginning of study period.
• No past costs are used.

Bought 10 years ago for $1,000,000
Trade in now                 $    100,000 = First cost
Sunk costs                     $    900,000

REPLACEMENT STUDY-

So we have come across many principles like equivalence, alternatives, basis of the comparison of alternatives. Now in normal times, you have many alternatives and the organisation has to decide whether they want to go with the present alternative or they want to switch over to the new alternative. These can be in terms of a service on an equipment.

So the problem often faced by the management is whether to buy a new equipment which is supposed to be more efficient or you should continue to use the existing equipment. So basically in economic terms you will have to evaluate whether you want to continue with the existing equipment which was purchased maybe few years back and it has still some life or, sometimes the salesman offers you to purchase new equipment certainly add some added cost. But maybe that will be offset by the lower operating costs and also the life which is ahead. Now decisions of this type is very important in economic analysis because if the decision is not right, that may lead to loss or failure of certain investment. So failure to make such decision at appropriate time may result in slow down or shut down of operations.

Now these class of decision problems where you have certain alternatives and you have to decide whether you should go with the existing alternative or you should switch over to a new alternative which is suggested to you, they these type of problems are coming under the category of replacement problems. Now for that you need knowledge of basic concepts and terminologies which is for replacement analysis because they are important. You must be conversant with all the principles which are to be used for economic analysis for both the alternatives. Now there are certain basic concepts and terminologies in replacement analysis

First Costs of Defender/Challenger

Viewpoint taken for a replacement analysis dictates that the first costs are estimated as follows:

1. The proper first cost to apply to keeping the defender in service for it’s remaining life- is its current Market Value 2. The proper first cost to apply to a challenger asset that might replace the current defender asset – is its investment cost P, which may be reduced if defender could actually be traded-in for value higher than its estimated market value, in this case it is P – (TIV-MV)defender

Defender First Cost

MVdefender

Challenger first cost

Amount of capital used to replace the defender with the challenger

Usually equals challenger initial investment, P

Sometimes equal to P - (TIV - MV)defender

Extra Information:

NEED OF REPLACEMENT-

it is carried out when there is a need to replace the currently owned equipment/ Machinery/ Asset

IT is a decision-Making Tool

Helps In:

• increase production
• increase the growth of the company
• choose the best alternative
• technology Advancement in the company

Reasons For REpalcement

• reduction in the productivity of currently owned equipment.
• increases in operating and maintenance cost far the construction
• need for production increase
• OBSOLESCENCE
• Depletion- loss of market value
• Deterioration

Present machine>>>>>>>Defender (Existing equipment)

New machine>>>>>>>>>Challenge(Proposed REplacement)

Cost of Defender VS cost oF Challenger

NOTE : Compare the best challenger to the current defender