Facility or asset has limited useful life. There is no asset that will last forever, at the definitive time they may changed into the newest yet powerful asset. When we purchase the assets, Economic value and also the useful life will affect  first consideration to buy. Replacement analysis is the art or technique to estimate the right time when the asset will be replaced.

There are so many reason why we need replacement analysis just like the former asset has limited capacity then it need adding capacity, the production cost tend to over budget due to low performance of the assets, deterioration due to aging when the value of some asset is loss due to the aging process, obsolescent means there were new or more enhance technology that may replace the former one. letting the aging equipment is very risky and will increase the negative impact such as: low income, higher defect, low customer satisfaction, low employee morale, higher injury and many more.

To comprehend enough about replacement analysis, it is better you learn about these replacement’s terms:

■Defender is a term for an old machine which will be replaced

■Challenger is a term for a new machine which will substituted the oldest assets

■Current market value is a term for selling price of the defender in the market place

■Sunk cost is a term for any past cost unaffected by any future decisions

■Trade-in allowance is a term for value offered by the vendor to reduce the price of a new equipment

There are signs that the defender should be replaced including:

1. determine the Current market value of defenders or former assets, somehow the obsolete one still have the value power although it valued relatively small
2. investigate the Operational cost (annually), the older an asset the bigger cost will include because the maintenance cost will valued higher at the upcoming later. So in this case it is a sign the this asset should be replaced
3. When the operational income is less and can not cover the targeted demand means the assets should be added
4. There is a probability that the assets will have zero salvage value so better to replaced quickly as long as it still the market value
5. The remaining residual life is closer to the period that the asset will no longer performed at all. Getting the right machine will take some times so you may consider to conduct replacement analysis at this time

beside defender requirements, there are also challenger requirements as follow:

1. Replacing the new asset means new investment will offer better performance and will assure the quality issue and targeted demand
2. New assets will also require operational cost so make sure that the cost is relatively small for a long period
3. new asset should increase the company income for a long period
4. make sure the salvage value for future still have the market value although it is small
5. Company should determine planned economic life, which means the asset still have market value and people is willing to buy it although it secondhand. Somehow we don’t wait until its over, we can change the asset at planned economic life

Planned replacements can be scheduled to minimize the cost and time of disruption however the unplanned replacements can be very costly or ever, as with an airplane engine, potentially catastrophic.

now lets apply to a case again:

A calculator SK-30, bought 2 years a go for $1600, has straight line depreciation with 4 years economic life. It has no salvage value.  The new type of calculator makes the former version has decrease its value form $1600 to $995. A company has offered an exchange with EL-40 for $ 1200 and SK-30 for $ 300. The current market value for  EL-40 is actually $ 1050 and SK-30 is around $ 200. Determine the the right price for SK-30 if we want to change into the new calculator?

according to this case lest analyze the price in every situation, From the example, there are five values ​​for SK-30 such as :

1. initial value: calculator has bought for $1600
2. current value: calculator will be sold for $995
3. book value: $1600 – 2/4(1600 – 0) = $800
4. exchange value: $300
5. market value: $200

so the right price for calculator is $200 and This is the most relevant price!. Exchange value seems logical but actually we buy new calculator with higher price than the original one.

Remaining useful life for defender is determining how long the facility/asset can be used with minimum operational cost and minimum maintenance cost  and owning cost (capital cost). Replacement analysis are focuses on annual marginal cost and on EUAC values.  Why? the alternative challenger and defender will have different useful life and will be trouble to pick the best one if we apply another method. Most industry the expenditures are normally monitored by annual budget. So how to determine remaining useful life? just determine EUAC that has minimum value.

Economic service life = a period which EUAC is minimum

 

credit:Photo by Jon Tyson on Unsplash

reference: Newnan (2012)