Replacement studies Construction Engineering 221 Economic Analysis

Replacement Studies Opportunity costs is a conceptual term referring to the foregone returns of an investment not pursued, or what you will lose by not doing anything Opportunity costs are most often representing in engineering economics problems as the cash flows forfeited by not selling (replacing) an asset before its useful life is up

Replacement Studies When examining whether to continue using (economically) an existing process or product (equipment), the calculation is called a replacement study Any of the basic methods will work for comparison, but the annual cost method is most common Existing equipment is sometimes called the defender and the new is the challenger

Replacement Studies Salvage in replacement studies is an estimate of future value (F) Treat salvage as an opportunity cost- not as a trade-in cost (keep defender costs and values together, and separate from the challenger costs and values) Convention is to use present value if lives are equal and annualized cost if lives are different because discount of F will vary based on number of terms

Replacement Studies Economic life- when the cost to keep an asset (O & M) exceeds the value (revenue) it can produce. Cost to keep is sum of amortized initial cost (decrease with time) PLUS the operating cost (increase with time) Summation of amortization and operation produces a U-shaped curve

Replacement Studies Economic life calculation amortization operation $ time $ Economic life

Replacement Studies Example 16 on page 39 is a good illustration of replacement scheduling calculations Replacement schedules are only as good as the data/ estimates used to calculate operation costs and economic life.