Replacement Analysis

When considering replacement or other equipment investment alternatives, it is important to remember that the past may be used as a guide to the future. 

A distinction should be made between replacement of equipment due to its physical conditions and displacement  of the equipment due to obsolescence. Each new project. each new equipment model. and even each improvement to existing equipment models raises the issue of an investment opportunity by displacement. Contractors generally consider equipment replacement when downtime becomes excessive or when the time for a major overhaul approaches. Some owners review their equipment condition when awarded a new job  and make replacement decisions at that time. Other contractors may review their equipment at end of the year and, based upon the tax position and available capital, make their replacement decisions then. However, it may be solved, the problem of replacing equipment is a frequently recurring one. 

Many general rules for replacement have been offered. One is to replace when the anticipated operating and overhaul costs plus the decrease in salvage value during the next period of use are the same or greater than the exasperating fixed-charge costs for a new piece of equipment. A similar rule is "as long as the average cost is greater than the marginal cost of extending the life of the equipment by one additional year, do not replace - as soon as the marginal cost of one additional year's  service exceeds the average cost, the asset should be replaced". 

In practice, each time a piece of equipment is repaired, the cumulative cos; per service hour is increased. The question becomes one of whether the repaired equipment can then earn enough to provide economic justification for the repair. The decision may be based upon previously established guidelines or upon a analysis of the specific piece. Guidelines may he used as a matter of policy: for example, previous replacement analysis may have consistently shown that the type of equipment in question should be replaced immediately prior to the second overhaul. By using such a policy, the losses are restricted to the dispersion of individual cases from the average. Records will generally show that the magnitudes of the losses warrant individual consideration. 

Equipment replacement analysis will generally contain the following factors 

1. The Value of Money :  Interest rates are used for determining the cost of equipment and also for adjusting cost to a common time value. 
2. Inflation :  The inflation rate should be applicable to the cost adjusted. 
3. Taxes :  The method used should convert costs to a noncom tax basis before comparing them. 
4. Salvage Values :  If a trade-in offer is more than the cash value of an equipment, the difference is actually a reduction in the price of new equipment. 
5. Utilization :  In comparing alternatives, the cost should be based upon the amount of work that will be accomplished by the alternative rather than on the cost. 
6. Standby Uses : Alternative uses of present equipment, such as standby uses, should be weighed against keeping the old equipment on the job or replacing it with new.