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IEEN 5329 Homework 9 11

Economics

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IEEN 5329

Homework 9

11.4, 11.10, 11.16, 11.33

 

Foundations of Replacement

11 (1) Identify the basic assumptions made specifically about the challenger alternative when a replacement study is performed.

11.2 In a replacement analysis, what numerical value should be used as the first cost for the defender? How the value is best obtained?

11.3 Why is it important to take a consultant's viewpoint in a replacement analysis?

11.4 Chris is tired of driving the old used car she bought 2 years ago for $18000. She estimates ii is worth about $8000 now. A car salesman gave her this deal: "Look, I will give you $10,000 in trade for this year's model. This is $2000 more than you expect and it is $3000 more than the current official Kelly Blue Book value for your car. Our sales price for your new car is only $28000, which is $6000 less than the manufacturer's sticker price of $34,000. Considering the extra $3000 on the trade-in and the $6000 reduction from sticker. You are paying $9000 less for the new car. So, I am giving you a great deal, and you get $2000 more for your old clunker than you estimated it was worth. So, let's trade now. Okay?" if Chris were to perform a replacement study as this moment, what is the correct first cost for (a) the defender and (b) the challenger?

11.5 New microelectronics testing equipment was purchased 2 years ago by Mytesmall Industries at a cost of $600.000. At that time it was expected to be used for 5 years and then traded or sold for its salvage value of $75,000. Expanded business in newly developed international markets is forcing the decision to trade now for a new unit at a cost of $800,000. The current equipment could be retained, if necessary for another 2 years, at which time it would have a $5000 estimated market value. The current unit is appraised at $350,000 on the international market and if it is used for another 2 years. It will have M&O costs (exclusive of operator costs) of $125,000 per year. Determine the values of P.S. and AOC for this defender if a replacement analysis were performed today.

 11.6 Buffett Enterprises installed a new fire monitoring and control system for its manufacturing process lines in California exactly 2 years ago for $450,000 with an expected life of 5 years, The market value was described then by the relation $400,000 - 50,000. Where k was the years from time of purchase. Previous experience with fire monitoring equipment indicated that its annual operating costs follow the relation 10,000 + 100k3. If the relations are correct over time. Determine the values of P, S, and AOC for this defender if a replacement analysis is performed (a) now with a study period of 3 years specified and (b) 2 years from now with no study period identified.

11.7 A machine purchased 1 year ago for $85.000 costs more to operate than anticipated. When purchased the machine was expected to be used for 10 years with annual maintenance costs of $22,000 and $10,000 salvage value. However, last year, it cost the company $35,000 to maintain it and these costs are expected to escalate to $36,500 this year and increase by $1500 each year thereafter The salvage value is now estimated to be $85,000 — $10,000k. Where k is the number of years since the ma-chine was purchased. It is now estimated that this machine will be useful for a maximum of 5 more years. Determine the values of P, AOC n and S for a replacement study performed now.

Economic Service Life

11.8 Halcrow, Inc. expects to replace a down time tracking system currently installed on CNC machines. The challenger system has a first cost of $70,000 an estimated annual operating cost of $20,000 a maximum useful life of 5 years and a $10,000 salvage value anytime it is replaced. At an interest rate of 10% per year, determine its economic service life and corresponding AW value. Work this problem using a hand calculator.

11.9 Use a spreadsheet to work Problem 11.8 and plot the total AW curve and its components, (a) using the estimates originally made and (b) using new, more precise estimates. namely, an expected maximum life of 10 years, an AOC that will increase by 15% per year from the initial estimate of $20,000 and a salvage value this is expected to decrease by $1000 per year from the $10,000 estimated for the first year.

11.10 An asset with a first cost of $250,000 is expected to have a maximum useful life of 10 years and a market value that decreases $25,000 each year. The annual operating cost is expected to be constant at $25,000 per year for 5 years and to increase at a substantial 25% per year thereafter. The interest rate is a low 4% per year, because the company, Public Services Corp., is majority-owned by a municipality and regarded as a semiprivate corporation that enjoys public project interest rates on its loans. (a) Verify that the ESL is 5 years, Is the ESL sensitive to the changing market value and AOC estimates? (b) The engineer doing a replacement analysis determines that this asset should have an ESL of 10 years when it is pilled against any challenger. IF the estimated AOC series has proved to be correct, determine the minimum market value that will make ESL equal 10 years. Solve by hand or spreadsheet as instructed.

11.11 A new gear grinding machine for composite materials has a first cost of P $100,000 and can be used for a maximum of 6 years. Its salvage value is estimated by the relation $= P(0.85) where n is the number of years after purchase. The operating cost will be $75.000 the first year and will increase by $10,000 per year thereafter. Use i =18% per year.

(a) Determine the economic service life and corresponding AW of this challenger.

(b) It was hoped that the machine is economically justified for retention for all 6 years, but that is not the case since the ESL in part (a) is consider-ably less than 6 years. Determine the reduction in the first cost that would have to be negotiated to make the equivalent annual cost for a full 6 years of ownership numerically equal to the AW estimate determined for the calculated ESL. Assume all other estimates remain the same, and neglect the fact that this lower P value will still not make a newly calculated ESL equal 6 years.

11.12 (a) Set- up a general (cell reference format) spreadsheet that will indicate the ESL and associated AW value for any challenger asset that has a maximum useful life of 10 years. The relation for AW should be a single-cell formula to calculate AW for each year of ownership, using all the necessary estimates.

(b) Use your spreadsheet to find the ESL, and AW values for the estimates tabulated. Assume i= 10% per year.

Year	Estimated Market Value, $	Estimated AOC, $
0	80000	0
1	60000	60000
2	50000	65000
3	40000	70000
4	30000	75000
5	20000	80000

 

11.13 A piece of equipment has a first cost of $150,000, a maximum useful life of 7 years, and a salvage value described by $ = 120,000- 20.000k, where k is the number of years since it was purchased. The salvage value does not go below zero. The AOC series is estimated using AOC 60,000 + 10,000k. The interest rate is 15% per year. Determine the economic service life (a) by hand solution, using regular AW computations, and (b) by computer, using annual marginal cost estimates.

11.14 Determine the economic service life and corresponding AW for a machine that has the following cash flow estimates. Use an. interest rate of 14% per year and hand solution.

Year	Estimated Market Value, $	Estimated Cost, $
0	100000	-
1	75000	-28,000
2	60000	-31,000
3	50000	-34,000
4	40000	-34,000
5	25000	-34000
6	15000	-45,000
7	0	-49,000

 

11.15 Use the annual marginal costs to find the economic service life for Problem 11.14 on a spreadsheet Assume the salvage values are the best estimates of future market value. Develop an Excel chart of annual marginal costs (MC) and AW of MC over the 7 years,

Replacement Study

11.16 During a 3 year period shanna, a project manager with sherliolme Medical devices, performed replacement studies on microwave based cancer detection equipment used in the diagnostic labs, she tabulated the ESL and AW values each year.

 (a)  What decision should be made each year?

 (b) From the data, describe what changes took place in the defender and challenger over the 3 years.

 

	Maximum Life, Years	ESL, Years	AW, $/year
Defender (Ist Year)	3	3	-10,000
Challenger	10	5	-15,000
Defnder (II Year)	2	1	-14,000
Challenger I	10	5	-15,000
Defender	1	1	-14,000
Challenger 2	5	3	-9,000

 

 11.17 A consulting aerospace engineer at Aerospatial estimated AW values presently owned. Highly accurate steel river inserter based on company records of similar equipment.

If Retained This Number of Years	AW Value, $/Year
1	-62,000
2	-50,000
3	-47,000
4	-53000
5	-70,000

 

A challenger has ESL- 2 years and AW=$-49,000 per year. If the consultant must recommended a replace decision today, should the company purchase the challenger? The MARR is 15% per year.

11.18 If a replacement study is performed and the defender is selected for retention for years. Explain what should be done 1 year later if a new challenger is identified.

11.19 Bio health, a biodevic system leasing company. Is considering a new equipment purchase to replace a currently owned asset that was purchased 2 years ago for $250.000. It is appraised at a current market value of only $50.000. An up-grade is possible for $200,000 now that would be adequate for another 3 years of lease rights, after which the entire system could be sold on the international circuit for an estimated $40.000. The challenger can be purchased at a cost $300,000 has an expected life of 10 years and has a $50,000 salvage value. Determine whether the company should upgrade or replace at a MARR of 12% per year, Assume the AOC estimates are the same for both alternatives.

11.20 For the estimates in Problem 11.19, use a spreadsheet-based analysis to determine the maximum first cost for the augmentation of the current system will make the defender and challenger break even. If this a maximum or minimum for the upgrade, lf the current system is to be retained?

11.21 A lumber company that cuts fine woods for cabinetry is evaluating whether it should retain the current bleaching system or replace it with a new one. The relevant casts for each system are known or estimated. Use an interest rate of 10% per year to (a) perform the replacement analysis and (b) determine. The minimum resale price needed to make the challenger re-placement choice now, is this a reasonable amount the expect for the current system?

	Current System	New System
First cost 7 years ago, $	-450,000
First Cost, $		-700,000
Remaining Life, years	5	10
Current market value, $	50000
AOC, $ per year	-160,000	-150,000
Future Salvage, $	0	50,000

 

11.22 Five years ago, the Nuyork Port Authority purchased several containerized transport vehicles for $350,000 each. Last year a replacement study was performed with the decision to retain the vehicles for 2 more years. However, this year the situation has changed in that each transport vehicle is estimated to have a value of only $8000 now. If they are kept in service, upgrading in a cost of $50.000 will make them useful for up to 2 more years. Operating cost is expected to be $10000 the first year and $15,000 second year, with no salvage value at all. Alternatively the company can purchase a new vehicle with an BSL of 7 years, no salvage value, and an equivalent annual cost of $-55.540 per year. The MARR is 10% per year. If the bud-get to upgrade she current vehicles is available this year. use these estimates to determine (a) when the company should replace the upgraded vehicles and (b) the minimum future salvage value of a new vehicle necessary to indicate that purchasing now is economically advantageous to upgrading.

11.23 Annabelle went to work this month for Caterpillar, a heavy equipment manufacturing company. When asked to verify the results of a replacement study that concluded in favor of the challenger, a new piece of heavy-duty metal forming equipment for the bulldozer processing plant, at first she concurred because the numerical results were in favor of this challenger.

	Challenger	Defender
Life, Years	4	6 more
AW, $ per year	-80,000	-130,000

 

Curious about past decision of this same kind, she learned that similar replacement analyses had been performed three previous times every 2 years for the same category of equipment. The decision was consistently to replace with the then current challenger. During her study, Annabelle concluded that the ESL values were not determined prior to comparing AW values in the analyses made 6.4. and 2 years ago. She reconstructed as best as possible the analyses for estimated Life,

Study performed this Many Years Ago	Defender				Challenger
	Life, Years	AW, $/Year	ESL, Years	AW, $/Year	Life, Years	AW, $/Year	ESL, Years	AW, $/Year
6	5	-140	2	-100	8	-130	7	-80
4	6	-130	5	-80	5	-120	3	-90
2	3	-140	3	-80	8	-130	8	-120
Now	6	-130	1	-100	4	-80	3 or 4	-80

 

 

11.24 Herald Richter and Associates 5 years ago purchased for $45.000 a microwave signal graphical plotter for corrosion detection in concrete structures. It is expected to have the market values and annual operating costs shown for the rest of its useful life of up to 3 years. It could he traded now at an appraised market value of $8000.

Year	Market Value Year at End of Year, $	AOC, $
1	6000	-50,000
2	4000	-53,000
3	1000	-60,000

 

A replacement plotter with new internet based digital technology costing $125,000 has an estimated $10,000 salvage value after its 5 year At an interest rate of 15% per year, determine how many more years Richter should retain ESL, and associated AW values as tabulated. All cost amounts are rounded and in $1000-per-year units. Determine the two sets of replacement study conclusions (that is, life-based and ESL -based), and decide if Annabelle is correct in her initial conclusion that were the ESL and AW values calculated, the pattern of replacement decisions would have been significantly different.

The present plotter. Solve (a) by hand and (b) using a spreadsheet.

11.25 What is meant by the opportunity-cost approach in a replacement study?

11.26 Why is it suggested that the cash How approach not be used when one is per-forming a replacement study?

11.27 Two years ago. Geo-Sphere Spatial, Inc. (GSSI) purchased a new GPS tracker system for $1,500,000. The estimated salvage value was $50,000 after 9 years. Currently the expected remaining life is 7 years with an AOC of $75,000 per year. A French corporation, LA Aramis, has developed a challenger that costs $400,000 and has no estimated 12 year life, $35,000 salvage value and AOC of $50,000 per year, use a spreadsheet of hand solution (as instructed) to (a) find the minimum trade in value necessary now to make the challenger economically advantageous, and (b) determine the number of years to retain the defender to just break even if the trade-in offer is $150.000. Assume the $50.000 salvage value can be realized for all retention periods up to 7 years.

11.28 Three years ago, Mercy Hospital significantly improved its hyperbaric oxygen (HBO) therapy equipment for advanced treatment of problem wounds. Chronic bone infections and radiation injury. The equipment cost $275.000 then and can be used for up to 3 years more. If the HBO system is replaced now, the hospital can realize $20,000. If retained, the market values and operating costs tabulated are estimated. A new system, made of a composite material, is cheaper to purchase initially at $150.000 and cheaper to operate during its initial years. It has a maximum life of 6 years, but market values and AOC change significantly alter 3 years of use due to the projected deterioration of the composite material used in construction. Additionally, a recurring Cost of $40,000 per year to inspect and rework the composite material is anticipated after 4 years of use. Market values, operating cost, and material rework estimates are tabulated. On the basis of these estimates and i = 15% per year. What are the ESL and AW values for the defender and challenger, and in what you should the current HBO system be replaced? Work this problem by hand. (See Problems 11:29 and 1131 for mom questions using these estimates.)

 

 

Year	Current HBO System		Proposed HBO System
	Market Value, $	AOC, $	Market Value, $	AOC, $	Material rework, $
1	10,000	-50,000	65,000	-10,000
2	6000	-60,000	45,000	-14,000
3	2,000	-70,000	25,000	-18,000
4			5000	-22,000
5			0	-26,000	-40,000
6			0	-30,000	-40,000

 

11.29 Refer to the estimates of Problem 11.28.

(a) Work the problem, using a spread-sheet. (b) Use Excel's SOLVER to determine the maximum allowed rework cost of the challenger’s composite material in years 5 and 6 such that the challenger’s AW value for 6 years will exactly equal the defender’s AW value at its ESL. Explain the impact of this lower rework cost on the conclusion of the replacement study.

Replacement Study over a Study Period

11.30 Consider two replacement studies to be performed using, the same defenders and challengers and the same estimated costs. For the first study, no study period is specified for the second a study period of 5 years is specified.

A) State the difference in the fundamental assumptions of the two replacement studies.

B) Describe the differences in the procedures followed in performing the replacement studies for the conditions:

11.31 Reread the situation and estimates explained in Problem 11.28. (a) Perform the replacement study for a fixed study period of 5 years. (b) lf in lieu of the challenger purchase a full-service contract for hyperbaric oxygen therapy Were offered to Mercy Hospital for a total of $85.000 per year if contracted for 4 or 5 years or $100,000 for a 3-year or less contract, which option or combination is economically the best between the defender and the contract?

11.32 An in-place machine has an equivalent annual worth of $-200,000 for each year of its maximum remaining useful life of 2 years. A suitable replacement is determined to have equivalent annual worth values of 300.000. $-225.000. and S-275,000 per year. if kept for 1. 2. or 3 years respectively. When should the company replace the machine, if it uses a fixed 3-year planning horizon? Use an interest rate of 18% per year.

11.33 Use a spreadsheet to perform a replacement analysis for the following situation. An engineer estimates that the equivalent annual worth of an existing machine over its remaining useful life of 3 years is $-90.000 per year. It. can he replaced now nr after 3 years with a machine that will have an AW of $-90,000 per year if kept for 5 years or less and $-110,000 per year if kept for 6 to 8 years.

a) Perform the analysis to determine the AW value for study period of length 5 through 8 years at an interest rate of 10% per year. Select the study period with the lowest AW value. How many years are the de-fender and challenger used? (b) Can the PW values be used to select the best study period length and decide to retain or replace the defender" Why or why not?

11.34 Nabisco Bakers currently employs staff to operate the equipment used to sterilize much of the mixing, baking, and packaging facilities in a large cookie and cracker manufacturing plant in Iowa. The plant manager, who is dedicated to cutting costs but not sacrificing quality and cleanliness, has the projected data were the current system retained for up to its maximum expected life of 5 years. A. Contract Company has proposed a turnkey sanitation system for $5.0 million per year if Nabisco signs on for 4 to 10 years and $5.5 million per year for a smaller number of years.

(a) At an MARR = 8% per year, perform a replacement study for the plant manager with a fixed planning horizon of 5 years. When it is anticipated that the plant will be shut down due to age oldie facility and projected technological obsolescence. As you perform the study take into account the fact that regardless of the number of years that the current sanitation system is retained, a one-time close-down cost will be incurred for personnel and equipment during the last year of operation. 

(b) What is the percentage change in AW amount each year of the 5 year study period? If the decision to retain the current sanitation system is made. What is the economic disadvantage in AW amount compared to the of the best economic retention period?

Year Retained	Current Sanitation System Estimates
	AW, $/year	Close-down Expense Last Year of Retention, $
0		-3,000,000
1	-2,300,000	-2500,000
2	-2300,000	-2000000
3	-3000000	-1000000
4	-3,000,000	-1,000,000
5	-3,500,000	-500,00

 

11.35 A machine that was purchased 3 years ago for $140,000 is now too slow to satisfy increased demand. The machine can he upgraded now for $70.000 or sold to a smaller company for $40,000. The current machine will have an annual operating cost of $85,000 per year. if upgraded presently owned machine will he kept in service for only 3 more years, then replaced with a machine that will be used in the manufacture of several other product lines. This replacement machine which will serve the company now and for at least 8 years, will cost $220,000. Its salvage value will be $50,000 for years through 5; $20,000 after 6 years: and $10,000 thereafter. It will have an estimated operating cost of $65,000 per year. The company asks you to perform an economic analysis at 20% per year, using a 5-year time horizon. Should the company replace the presently owned machine now, or do it 3 years from now? What are the AW values?

 

FE REVIEW PROBLEMS

11.36 Equipment purchased 2 years ago for $70,000 was expelled to have a useful life of 5 years with a $5000 salvage value. Its performance was less than expected, and it was upgraded for $30,000 one year ago. Increased demand now requires that the equipment he upgraded again for an additional $25,000 or replaced with new equipment that will cost $85000, If re-placed the existing equipment will be sold for $6000. In conducting a replacement study, the first cost that should be used for the presently owned machine is:

a) $31,000

b) $25,000

c) $6,000

d) $22,000

11.37 In a make/buy replacement study over a 4 year study period, a subcomponent is currently purchased under contract. The challenger system necessary to make the component inhouse has an expected useful life of up to 6 years and an economic service life of 4 years. The current contract can be extended for up to 2 more years. The number of options available for the make/buy decision is: (a) None (b) One (c) Two (d) Three

11.38 The economic service life of an asset is: (a) The longest time that the asset will still perform the function that it was originally purchased for.

b) The length of time that will yield the lowest present worth of costs.

c) The length of time that will yield the lowest annual worth of costs

d) The time require for its market value to reach the originally estimated salvage value.

11.39 In a replacement study conducted last year. it was determined that the defender should be kept for 3 more years. Now, however, it is clear that some of the estimates made last year for this year and next year have changed substantially. The proper course of action is to: (a) Replace the existing asset now. (B) Replace the existing asset 2 years from now, as was determined last year. (C) Conduct. a new replacement study using the new estimates. (d) Conduct new replacement study using last year's estimates.

11.40 The AW values calculated for a retain-or-replace decision with no stated study period are as shown.

Year	AW to Replace, $/Year	AW to Retain, $/Year
1	-25,500	-27,000
2	-25,500	-26,500
3	-26,900	-25,000
4	-27,000	-25,900

 

The defender should be replaced:

(a) After 4 more years.

(b) After 3 more years.

(c) After 1 more year (d)  Now

EXTENDED EXERCISE

ECONOMIC SERVICE LIFE UNDER VARYING CONDITIONS

New pumper system equipment is under consideration by a Gulf Coast chemical processing plant. One crucial pump moves highly corrosive liquids from specially lined tanks on inter coastal barges life storage and preliminary relining facilities dockside. Because of the variable quality of the raw chemical and the high pressures imposed on the pump chassis and impellers, a close log is maintained on the number of hours per year that the pump operates. Safety records and pump component deterioration are considered critical control points for this system. As currently planned, rebuild and M&O cost estimates are increased accordingly when cumulative operating time reaches the 6000-hour mark, Estimates made for this pump are as follows.

First Cost: $-800,000

Rebuild Cost: $ - 150,000 whenever 6000 cumulative hours are logged. Each rework will cost 20% more than the previous one. A maximum of 3 rebuilds is allowed.

M&O Costs: $25,000 for each year 1 through 4. $40000 per year starting the year after the first rebuild. Plus 15% per year thereafter

MARR: 10% per year

Based on previous logbook data, the current estimates for number of operating hours per year are as follows:

Year	Hours per Year
1	500
2	1500
3 on	2000

 

Questions 1 Determine the economic, service life of the pump.

2. The plant superintendent told the new engineer on the job that only one re-build should be planned for, because these types of pumps usually have their minimum cost life before the second rebuild. Determine a market value for this pump that will force the ESL to be 6 years.

3. The plant superintendent also told the safety engineer that they should not plan for a rebuild after 6000 hours, because the pump will he replaced after a total of 10,000 hours of operation. The safety engineer wants to know what the base AOC in year I can be to make the ESL 6 years. The engineer assumes now that the 15% growth rate applies from year I forward. How does this base AOC value compare with the rebuild cost after 6000 hours?

 

CASE STUDY

REPLACEMENT ANALYSTS FOR QUARRY EQUIPMENT

 Equipment: used to move raw material from the quarry to the rock crushers was purchased 3 years ago by Tres Cenetos, SA. When purchased, the equipment had P =$85,000. N= 10 years, S= $5000, with an annual capacity Of 180,000 metric tons. Additional equipment with a capacity of 240,000 metric tons per year is now needed. Such equipment can be purchased for p = $70,000, n == 10 years, S= $8000. However, a consultant has pointed out that the Company can construct conveyor equipment to move the material from the quarry. This will cost an estimated $115,000 with a life of 15 years and no significant salvage value, It will carry 400,000 metric tons per year. The company needs some way to move material to the conveyor in the quarry. The presently owned equipment can be used but it will have excess capacity. If new smaller-capacity equipment is purchased there $15,000 market value for the currently use equipment. The smaller capacity equipment will require a capital outlay of $40,000 with An estimated life of n: 12 years and $3500. The capacity is 400,000 metric tons per year over this short distance. Monthly operating maintenance and insurance costs will average $0.01 per ton-kilometer for the movers. Corresponding costs for the conveyor are expected to be $0.0075 per metric ton.

The company wants to make 12% per year on this investment. Records show that the equipment must move raw material an average of 2.4 kilometers from the quarry to the crusher pad. The conveyor will be placed to reduce this distance to 0.75 kilometer.