The replacement analysis is used to find out if an equipment is operating economically or if the operating costs can be decreased by purchasing a new equipment.
In addition, through this analysis it can be found out whether the current equipment should be replaced immediately or it is better to wait a few years, before changing it
Continuing with the analysis that the financial channel is making of the physical assets and as a complement to the articles made in the past, a detailed study of the importance in the decision-making made by the financial administrator at the time of replacing is presented below. your fixed resources.
Replacement analysis and planning
A physical asset replacement plan is vital in any economic process, because a hasty replacement causes a decrease in liquidity and a late replacement causes loss; This occurs due to increases in the cost of operation and maintenance, therefore, the opportune moment of replacement should be established, in order to obtain the greatest economic advantages.
A physical asset must be replaced when the following causes occur:
- Insufficiency. High maintenance cost. Obsolescence.
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In this type of analysis it is necessary to apply some fundamental concepts of financial mathematics
To make a replacement analysis, it is essential to determine:
The planning horizon
Also called the time interval, it is determined by the period during which the analysis is to be performed and the smaller the planning horizon, the more accurate the analysis becomes.
Capital availability
This to make the purchase of the assets as planned and projected.
The economic life of goods
Economic life is understood as the period for which the equivalent uniform annual cost is minimum. For old assets, the remaining useful life is not taken into account, since almost everything can be kept working indefinitely but at a cost that can be excessive if it is constantly repaired.
From the economic point of view, the most used techniques in the replacement analysis are
Optimal replacement period = Economic life
This technique consists of calculating the equivalent uniform annual cost of the asset, when it is retained for a certain number of years and in this way select the number of years for which the cost is minimal.
Example: A machine is currently purchased for $ 500,000, a rate of 20% of useful life per year is assumed, it is requested to determine the optimal replacement period taking into account the following information
|
Year |
Salvage value |
Annual cost of operation |
|
one |
$ 300,000 |
$ 21,000 |
|
two |
$ 200,000 |
$ 35,000 |
|
3 |
$ 137,000 |
$ 55,000 |
|
4 |
$ 71,000 |
$ 90,000 |
|
5 |
$ 0 |
$ 150,000 |
Solution:
1. First, the equivalent uniform annual cost (CAUE) is calculated when the asset is retained for one year with the following expression.
2. Using the same system and bringing the remaining years to present value, the equivalent uniform annual cost data is obtained for these.
Comment: To avoid cumbersome calculations, a list of CAUE values for each of the years is presented below.
|
Year |
Equivalent annual uniform cost (CAUE) |
|
one |
$ 321,000 |
|
two |
$ 263,727 |
|
3 |
$ 234,681 |
|
4 |
$ 225,128 |
|
5 |
$ 226,448 |
The analysis is based on the comparison of the data, it is observed that in the fifth year the cost increases, this means in this technique that the asset must be retained for only four years.
Over time the asset becomes obsolete because its annual cost of operation is increasing
Old-new confrontation
This technique consists of analyzing the advantages of the asset currently in use and comparing them with the advantages that a new asset would offer. When using this technique, estimates of the commercial value, salvage value and useful life of the asset must be taken into account.
Example: A factory bought a machine three years ago, it had a cost of $ 80,000, an estimated useful life of five years and a salvage value of $ 10,000. It is currently estimated that the remaining useful life is three years and they are proposing the purchase of a new machine that costs $ 90,000, has a useful life of eight years and a salvage value of 10% of its cost.
The seller of the new machine is offering to receive the old machine for $ 45,000, as part of payment. It is also verified that the repair costs of the old machine are $ 9,000 while in the new one they are estimated at $ 4,000.
If you want to get a 20% return on investment, determine if it is economically advisable to make the change.
Solution:
1. First, the data from the two machines are compared.
|
Ancient |
New |
|
| Initial cost |
$ 45,000 |
$ 90,000 |
| Annual cost of operation |
$ 9,000 |
$ 4,000 |
| Useful life |
3 |
8 |
| Salvage value |
$ 10,000 |
$ 9,000 |
2. CAUE is calculated for the old machine.
3. CAUE is calculated for the new machine.
4. The decision is made against the analysis made. In this case, the new machine is chosen because it has a lower cost.
Calculation of the critical exchange value
Many times, it is necessary to know the minimum exchange value of an old machine, before entering to negotiate a new machine, this value can be obtained by matching the CAUE of the new machine with the CAUE of the old machine.
Example:
A machine purchased four years ago has an annual operating cost of $ 85,000, a salvage value of $ 100,000, and a remaining useful life of four years. A new machine has been selected, whose cost is $ 900,000, has a useful life of twelve years, an annual cost of operation of $ 15,000 and each year increases by $ 10,000, its salvage value is $ 300,000. What should be the critical exchange value, assuming a rate of 22%?
Solution:
1. The CAUE for the old machine is calculated with a variable (X).
2. CAUE is calculated for the new machine.
CAUE (1) = $ 259,670.08
3. The CAUE of the old machine is equalized with the new one and the X is cleared.
X = $ 480,704.30
After carrying out this analysis, the responsibility falls on the good decision made by the financial administrator, therefore it is necessary that this is well founded in the area of financial mathematics.
