What is asset replacement rule for machinery

What is asset replacement rule for machinery?

Machinery which has lower annual equivalent cost should be selected. Annual equivalent cost can be calculated dividing the present cash flows with the annuity factor.

Asset Replacement Rule example

For example there are two machinery (X, Y) with cost 100 and 150 million respectively. Running cost of both machinery is 40 million per year and useful life is 2 & 3 years, then annual equivalent cost can be calculated as under;

Year	Initial	Running cost	Net Cash	Discount	PV
0	100		100	1	100
1		40	40	.909	36
2		40	40	.826	33
PV					169

Annuity Factor (2 Years) = 1.73

Equivalent machinery cost = 169/1.73

= 98 (first Machinery)

Year	Initial	Running cost	Net Cash	Discount	PV
0	100		130	1	130
1		40	40	.909	36
2		40	40	.826	33
		40	40	.751	30
PV					229

Annuity Factor= 2.48

Equivalent Machinery Cost= 229/2.48

=92 (second Machinery)

Second machinery has lower equivalent cash outflow, and therefore be selected.