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D1201 Engineering Risk and Benefit
Session 08
Replacement Analysis
Session 08
Reason for Replacement Analysis

Factors that must be considered in Replacement
Studies
When should a new truck replace
the existing truck?
When should a process be
redesigned?
When should a product be
The most common question asked in industry is: when should
redesigned?
the existing be replaced?
Engineering Economic Analysis - Ninth Edition Newnan/Eschenbach/Lavelle Copyright 2004 by Oxford University Press, Inc.
Replacement Analysis Terms

Defender: the existing equipment, building, or
decision previously implemented
Challenger: the proposed replacement currently
under consideration
Aspects of Replacement Analysis

1.Using available data to determine the analysis
technique
2.Determining the base comparison between
alternatives
3.Using analysis techniques when:
1.Defender marginal cost can be computed
and is increasing
2.Defender marginal cost can be computed
and is not increasing
3.Defender marginal cost is not available
4.Considering possible future challengers
5
5.After-tax analysis
The Replacement Problem

Engineers replace the existing due to:
Obsolescence: technological change
Depletion: loss of market value
Deterioration: wear that is overly expensive to
repair
Shall the defender be replaced now or be maintained for
one or more periods?
Issues (Consider Before Starting)

If a unit fails, must it be removed permanently
from service, or repaired?
Are standby units available if the system fails?
Do components or units fail independently of
the failure of other components?
Is there a budget constraint?
If the unit can be repaired after failure, is there
a constraint on the capacity of the repair
facility?
Issues (Continued)
Is only one replacement allowed over the
planning horizon? Are subsequent
replacements allowed at any time during the
study period?
Is there more than one replacement unit (price
and quality combination) available at a given
point in time?
Do future replacement units differ over time?
Are technological improvements considered?
Is preventative maintenance included in the
model?
Issues (Continued)
Are periodic operating and maintenance costs
constant or variable over time?
Is the planning horizon finite or infinite?
Are consequences other than economic effects
considered? (i.e., sociotechnical issues)
Are income tax consequences considered?
Is inflation considered?
Does replacement occur simultaneously with
retirement, or are there non-zero lead times?
Are cash flow estimates deterministic or
stochastic?
Analysis
Techniques
Replacement Analysis Decision Chart

Where
Compare
Defender
Marginal Cost
Defender
Marginal Cost
Defender
Best
Challenger
Available
Increasing
Next-year
Marginal Cost
EUAC at
Minimum
Cost Life
Available
Not increasing
EUAC at
Minimum Cost
Life
EUAC at
Minimum
Cost Life
Not available
EUAC over
Remaining
Useful Life
EUAC at
Minimum
Cost Life
10
What Is the Basic Comparison?

Identify the defender and the best challenger
Product
Machine
Process
Personnel
Mix
Decision Criteria leads to one of the following:
If the defender is more economical, it should be retained.
If the challenger is more economical, it should be installed.
11
Minimum Cost
Life of the
Challenger
EUAC Equivalent Uniform
Annual Cost
Example
12-1
Year
EUAC of
Capital
Recovery
Costs
EUAC of
Maintenance
and Repair
Costs
EUAC of
Operating
Costs
Initial year
-7500
-500
-900
-400
$0.00
$432.69
$853.87
$1,263.56
$1,661.82
$2,048.71
$2,424.30
$2,788.67
$3,141.93
$3,484.18
$3,815.55
$4,136.17
$4,446.19
$4,745.75
$5,035.01
$500.00
$692.31
$879.50
$1,061.58
$1,238.59
$1,410.54
$1,577.47
$1,739.41
$1,896.41
$2,048.53
$2,195.80
$2,338.30
$2,476.08
$2,609.22
$2,737.78
Arithmetic
gradient
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
EUAC Total
Interest
rate
8%
$8,100.00
$4,205.77
$2,910.25
$2,264.41
$1,878.42
$1,622.37
$1,440.54
$1,305.11
$1,200.60
$1,117.72
$1,050.57
$995.21
$948.91
$909.73
$876.22
$8,600.00
$5,330.77
$4,643.62
$4,589.55
$4,778.84
$5,081.62
$5,442.31
$5,833.19
$6,238.94
$6,650.43
$7,061.93
$7,469.68
$7,871.18
$8,264.69
$8,649.02
<-----MIN
EUAC is the number of years

at which asset cost in
minimized.
C o st
EUAC plot
$10,000.00
$9,000.00
$8,000.00
$7,000.00
$6,000.00
$5,000.00
$4,000.00
$3,000.00
$2,000.00
$1,000.00
$0.00
Capital Recovery
Maintenance and
Repair
Operating
Total
10
15
20
Year
12
Marginal Costs
Example 12-2
Expense
Investment Cost
Annual O&M
Cost
Annual Insurance
Cost
Useful Life
(years)
MARR
Year
0
1
2
3
4
5
6
7
Cost
$25,000.00
$ 2,000.00
$ 5,000.00
$ 1,500.00
Foregone
Interest
O&M Cost
$3,750.00
$2,700.00
$1,950.00
$1,350.00
$ 900.00
$ 600.00
$ 450.00
$
$
$
$
$
$
$
Loss in
Market
Value
25,000.00
18,000.00
13,000.00
9,000.00
6,000.00
4,000.00
3,000.00
2,500.00
$
$
$
$
$
$
$
7,000.00
5,000.00
4,000.00
3,000.00
2,000.00
1,000.00
500.00
Marginal Costs are the year-byyear costs for keeping an asset.
500.00
15%
Market Value
$
$
$
$
$
$
$
$
Years
Incremental
cost
thereafter
$
-
2,000.00
2,500.00
3,000.00
3,500.00
4,000.00
4,500.00
5,000.00
This example illustrates the

calculation of the marginal costs
for a new item.
Insurance
Cost
Total
Marginal
Cost
$ 5,000.00
$ 5,000.00
$ 5,000.00
$ 6,500.00
$ 8,000.00
$ 9,500.00
$11,000.00
$17,750.00
$15,200.00
$13,950.00
$14,350.00
$14,900.00
$15,600.00
$16,950.00
13
Marginal Cost Data Defender

Example 12-3
$15,000.00
Incremental
cost
thereafter
$
-
$10,000.00
$ 1,500.00
Expense
Investment Cost
Annual O&M
Cost
Annual Insurance
Cost
Useful Life
(years)
MARR
Year
0
1
2
3
4
5
6
7
Cost
15,000.00
14,000.00
13,000.00
12,000.00
11,000.00
10,000.00
Here the marginal costs are

increasing.
5
15%
Loss in
Market
Value
Market Value
$
$
$
$
$
$
Years
Is the marginal cost of defender

increasing?
$
$
$
$
$
1,000.00
1,000.00
1,000.00
1,000.00
1,000.00
Foregone
Interest
O&M Cost
Insurance
Cost
$2,250.00
$2,100.00
$1,950.00
$1,800.00
$1,650.00
$10,000.00
$11,500.00
$13,000.00
$14,500.00
$16,000.00
$
$
$
$
$
Total
Marginal
Cost
$13,250.00
$14,600.00
$15,950.00
$17,300.00
$18,650.00
14
Replacement Analysis Technique #1

Defender marginal costs are increasing
Challenger
Replace when the

marginal cost of
ownership of the
defender is more
than the EUAC of
the challenger.
25,000.00
Incremental cost
thereafter
$
-
2,000.00
500.00
5,000.00
1,500.00
Expense
Investment Cost
Annual O&M
Cost
Annual Insurance
Cost
Useful Life
(years)
MARR
Year
0
1
2
3
4
5
6
7
Market Value
$
$
$
$
$
$
$
$
25,000.00
18,000.00
13,000.00
9,000.00
6,000.00
4,000.00
3,000.00
2,500.00
Cost
Years
Example 12-4
7
15%
Loss in Market
Value
$
$
$
$
$
$
$
7,000.00
5,000.00
4,000.00
3,000.00
2,000.00
1,000.00
500.00
Foregone
Interest
$
$
$
$
$
$
$
3,750.00
2,700.00
1,950.00
1,350.00
900.00
600.00
450.00
O&M Cost
$
$
$
$
$
$
$
Insurance Cost
2,000.00
2,500.00
3,000.00
3,500.00
4,000.00
4,500.00
5,000.00
$
$
$
$
$
$
$
5,000.00
5,000.00
5,000.00
6,500.00
8,000.00
9,500.00
11,000.00
Total Marginal
Cost
$
$
$
$
$
$
$
17,750.00
15,200.00
13,950.00
14,350.00
14,900.00
15,600.00
16,950.00
EUAC through
year
$17,750.00
$16,563.95
$15,811.20
$15,518.57
$15,426.83
$15,446.61
$15,582.46
Min EUAC
<----MIN
Defender
$
15,000.00
Incremental cost
thereafter
$
-
10,000.00
1,500.00
Expense
Investment Cost
Annual O&M
Cost
Annual Insurance
Cost
Useful Life
(years)
MARR
Year
0
1
2
3
4
5
6
7
Market Value
$
$
$
$
$
$
15,000.00
14,000.00
13,000.00
12,000.00
11,000.00
10,000.00
Cost
Years
5
15%
Loss in Market
Value
$
$
$
$
$
1,000.00
1,000.00
1,000.00
1,000.00
1,000.00
Foregone
Interest
$
$
$
$
$
2,250.00
2,100.00
1,950.00
1,800.00
1,650.00
O&M Cost
$
$
$
$
$
10,000.00
11,500.00
13,000.00
14,500.00
16,000.00
Insurance Cost
$
$
$
$
$
Total Marginal
Cost
$
$
$
$
$
13,250.00
14,600.00
15,950.00
17,300.00
18,650.00
Challenger
Minimum EUAC
Results
$15,426.83
$15,426.83
$15,426.83
$15,426.83
$15,426.83
$15,426.83
$15,426.83
Replace
Replace
Replace
15
Analysis Technique # 1
Appropriate when replacement repeatability
assumptions hold
The best challenger will be available in all
subsequent years at the same economic cost
The period of needed service is infinite
These assumptions appear to be

rather restrictive.
16
Relaxing the Restrictions
This spreadsheet considers that:

The best challenger is available in subsequent years at the
same economic cost
The project life is known and limited
Based on Example 12-4

Interest rate
Project life
15%
4
>>>>>>>>
Keep Defender - Years
>>>>>>>>
Years
0
1
2
3
4
5
6
7
8
9
10
0
0
$13,250.00
$13,877.91
$14,474.62
$15,040.45
$15,575.80
1
$17,750.00
$15,343.02
$14,992.98
$15,130.57
$15,442.32
$15,824.17
2
$16,563.95
$15,301.84
$15,034.44
$15,140.86
$15,414.63
$15,767.77
3
$15,811.20
$15,031.11
$14,873.60
$15,004.82
$15,282.29
$15,635.35
Install and keep Challenger - Years

4
5
6
$15,518.57 $15,426.83 $15,446.61
$14,930.09 $14,926.65 $14,971.85
$14,813.79 $14,821.58 $14,865.67
$14,945.65 $14,942.33 $14,971.19
$15,214.37 $15,195.64 $15,207.03
$15,558.78 $15,526.33 $15,522.24
7
$15,582.46
$15,004.99
$14,899.10
$14,993.63
$15,216.06
$15,518.95
10
$15,030.12
$14,925.09
$15,011.42
$15,223.32
$15,516.27
$15,049.66
$14,945.70
$15,025.75
$15,229.25
$15,514.06
$15,065.15
$14,962.29
$15,037.42
$15,234.13
$15,512.23
17
Minimum Cost Life of the Defender

Example 12-7
Data
Depends on when
in the life of the
defender the
analysis is
computed.
Year
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
Partial life
10%
Salvage Value
at end of Year
n
$ 5,000.00
$ 4,000.00
$ 3,500.00
$ 3,000.00
$ 2,500.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
$ 2,000.00
Estimated
maintenance
costs for year
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
100.00
200.00
300.00
400.00
500.00
600.00
700.00
800.00
900.00
1,000.00
1,100.00
1,200.00
1,300.00
1,400.00
EUAC of
Capital
Recovery
EUAC of
Maintenance
EUAC Total
$1,500.00
$1,214.29
$1,104.23
$1,038.68
$991.39
$888.82
$816.22
$762.33
$720.92
$688.24
$661.89
$640.29
$622.34
$607.24
$594.42
$0.00
$47.62
$93.66
$138.12
$181.01
$222.36
$262.16
$300.45
$337.24
$372.55
$406.41
$438.84
$469.88
$499.55
$527.89
$1,500.00
$1,261.90
$1,197.89
$1,176.79
$1,172.41
$1,111.18
$1,078.38
$1,062.78
$1,058.16
$1,060.78
$1,068.29
$1,079.13
$1,092.21
$1,106.79
$1,122.31
Starting age
Ending age
15
Minimum
EUAC
EUAC of
Invested
Capital
EUAC of
Maintenance
EUAC
Total
Minimum
EUAC
<-----MIN
$850.00
$826.19
$803.17
$673.21
$595.70
$544.41
$508.11
$481.17
$460.46
$444.12
$430.94
$420.14
$411.17
$200.00
$247.62
$293.66
$338.12
$381.01
$422.36
$462.16
$500.45
$537.24
$572.55
$606.41
$638.84
$669.88
1,050.00
1,073.81
1,096.83
1,011.32
976.71
966.77 <-----MIN
970.27
981.61
997.70
1,016.66
1,037.35
1,058.99
1,081.05
Marginal
cost
$
$
$
$
$
$
$
$
$
$
$
$
$
Minimum
marginal
cost
250.00 <-----MIN
350.00
450.00
500.00
600.00
700.00
800.00
900.00
1,000.00
1,100.00
1,200.00
1,300.00
1,400.00
EUAC plot
1600
1400
1200
1000
Cost
Full life
Interest rate
EUAC Total
EUAC Total
800
600
400
200
0
0
10
15
20
Year
18

If the replacement repeatability assumption holds,
compare EUAC of the defender asset at its minimum cost
life against the EUAC of the challenger at its minimum cost
life.12-8 The repeatability assumptions do not hold.
Example
Interest rate
Project life
15%
4
>>>>>>>>
Keep Defender - Years
Do not
install
challenger
Years
0
1
2
3
4
5
6
7
8
9
10
0
0
$6,120.00
$4,043.08
$3,660.17
$3,691.20
$3,880.20
1
$8,600.00
$7,273.49
$5,355.37
$4,649.44
$4,419.25
$4,419.38
2
$5,330.77
$5,631.35
$4,597.52
$4,192.89
$4,093.89
$4,162.01
3
$4,643.62
$5,093.29
$4,352.37
$4,050.29
$3,990.05
$4,073.32
Install and keep Challenger - Years

4
5
6
$4,589.55
$4,778.84
$5,081.62
$4,986.56
$4,941.21
$4,909.43
$4,354.80
$4,376.01
$4,391.57
$4,079.51
$4,116.67
$4,144.84
$4,017.99
$4,052.04
$4,078.52
$4,091.22
$4,115.76
$4,135.22
7
$5,442.31
$4,886.13
$4,403.37
$4,166.74
$4,099.50
$4,150.88
10
$4,868.46
$4,412.54
$4,184.11
$4,116.40
$4,163.65
$4,854.72
$4,419.81
$4,198.09
$4,130.17
$4,174.17
$4,843.83
$4,425.66
$4,209.48
$4,141.52
$4,182.90
19

Compare the EUAC of the defender over its stated
life against the minimum EUAC of the challenger.
Here defining defender and challenger first costs
can be an issue.
Trade-in value is not a suitable value.

Appropriate value is the market value.
20
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D1201 Engineering Risk and Benefit

Reason for Replacement Analysis

Replacement Analysis Terms

Aspects of Replacement Analysis

The Replacement Problem

Issues (Consider Before Starting)

Replacement Analysis Decision Chart

What Is the Basic Comparison?

EUAC is the number of years

Marginal Costs are the year-byyear costs for keeping an asset.

This example illustrates the

Marginal Cost Data Defender

Here the marginal costs are

Is the marginal cost of defender

Replacement Analysis Technique #1

Replace when the

These assumptions appear to be

Relaxing the Restrictions

This spreadsheet considers that:

Based on Example 12-4

Keep Defender - Years

Install and keep Challenger - Years

Minimum Cost Life of the Defender

Replacement Analysis Technique #2

Keep Defender - Years

Install and keep Challenger - Years

Replacement Analysis Technique #3

Trade-in value is not a suitable value.

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