Asset
Replacement
In business we need to
replace the asset on regularly bases and therefore it is important to adopt a
proper strategy for asset replacements. Asset replacement you need to answer to
basic question
1.
How to replace the asset
2.
How often to replace the asset
Asset
Replacement Example
|
Particulars
|
Machine A
|
Machine B
|
|
Investment
|
$ 50 million
|
$ 30 Million
|
|
Life
|
3 Years
|
2 Years
|
|
Running
Cost
|
15 million
|
20 Million
|
|
Residual
Value
|
$ 8 Million
|
|
|
Cost
of capital
|
12%
|
12%
|
Which asset is to be select?
Solution
|
Year
|
Machine A
|
Machine B
|
Discount Factor
|
Machine A
|
Machine B
|
|
0
|
|
|
1
|
$50
|
$
30
|
|
1
|
15
|
20
|
.892
|
13.38
|
17.84
|
|
2
|
15
|
20
|
.797
|
11.9
|
15.94
|
|
3
|
7
|
20
|
.711
|
4.97
|
14.22
|
|
|
|
|
|
80.25
|
78
|
3. Calculate Equivalent Annual Cost
Formula = Present Value of
Cost/ Annuity Factor
|
|
Machine A
|
Machine B
|
|
Present
Value of Cost
|
80.25
|
78
|
|
Annuity
Factor 12 %
|
2
year= 1.69
|
3
years =2.4
|
|
EAC
|
47.48
|
32.5
|
Machine B is to be
selected because equivalent cash flow for the machine B is $ 32.5 which is
lower than 47.48 $ of machine A.
