Replacement Analysis with Tax Consideration Lecture No 48 Chapter 14 Contemporary Engineering Economics Copyright © 2016 th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Replacement Analysis with Tax Consideration • When computing the net proceeds from sale of the old asset, any gains or losses must be identified to determine the correct amount of the opportunity cost (Example 14.6) • Whenever possible, replacement decisions should be based on the cash flows after taxes (Example 14.7) • All basic replacement decision rules including the way of computing economic service life remain unchanged (Examples 14.8 and 14.9) th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 14.6: Net Proceeds from the Disposal of an Old Machine Given: Depreciation schedule, tax rate = 40%, and market value = $10,000 Find: Market value to be used in replacement analysis th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 14.7: Replacement Analysis Using the Opportunity Cost Approach Given: o o o o Depreciation schedule Tax rate = 40% Discount rate = 10% All other financial information as given in Example 14.2 Find: Whether or not to replace the defender now AECD = $7,524 AECC = $6,723 th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Excel Worksheet (Example 14.7) Defender Challenger th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 14.8: Economic Service Life of a Lift Truck on After-Tax Basis Given: Financial data as given in Example 14.3, depreciation schedule, tax rate = 40%, and discount rate = 9% Forecasted Operating Costs and Net Proceeds from Sale as a Function of Holding Period Find: Economic service life th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Economic Service Life Based on After-Tax Cash Flows th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Economic Service Life th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Example 14.9: Replacement Analysis under the Infinite Planning Horizon Defender Challenger th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Summary of Economic Service Lives Defender: o ND* = years o AECD* = $3,030 Challenger: o NC* = years o AECC* = $3,541 th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Equivalent Annual Cash Flow Streams PW for an infinite cash flow stream when the Defender is Kept for n Years followed by Infinitely Repeated Purchases of the Challenger Every Years th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Summary o In replacement analysis, the defender is an existing asset; the challenger is the best available replacement candidate o The current market value is the value to use in preparing a defender’s economic analysis Sunk costs—past costs that cannot be changed by any future investment decision—should not be considered in a defender’s economic analysis th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved o o o The opportunity cost approach views the net proceeds from sale of the defender as an opportunity cost of keeping the defender This approach works in all situations of replacement problems Economic service life is the remaining useful life of a defender, or a challenger, that results in the minimum equivalent annual cost or maximum annual equivalent revenue We should use the respective economic service lives of the defender and the challenger when conducting a replacement analysis th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved o Ultimately, in replacement analysis, the question is not whether to replace the defender, but when to so o The AEC method provides a marginal basis on which to make a year-by-year decision about the best time to replace the defender o As a general decision criterion, the PW method provides a more direct solution to a variety of replacement problems, with either an infinite or a finite planning horizon, or a technological change in a future challenger o The role of technological change in asset improvement should be weighed in making long-term replacement plans o Whenever possible, all replacement decisions should be based on the cash flows after taxes th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved .. .Replacement Analysis with Tax Consideration • When computing the net proceeds from sale of the old asset, any gains... conducting a replacement analysis th Contemporary Engineering Economics, edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved o Ultimately, in replacement analysis, the... of an Old Machine Given: Depreciation schedule, tax rate = 40%, and market value = $10,000 Find: Market value to be used in replacement analysis th Contemporary Engineering Economics, edition