Econ quiz 3 Ch 11, 13, 14, 16

AW values for a replacement study.

The AW values for the challenger and for the remaining life of the defender are not based on the economic service life; the AW is calculated over the study period only. What happens to the alternatives after the study period is not considered in the replacement analysis.

How is the ESL determined?

The ESL is determined by calculating the total AW of costs if the asset is in service for up to the last year the asset is considered useful.

How is breakeven point determined?

The break- even point QBE is determined from mathematical relations.

First cost P

The delivered and installed cost of the asset including purchase price

Recovery period n

The depreciable life of the asset in years

Economic Service Life

The economic service life (ESL) is the number of years n at which the equivalent uniform annual worth (AW) of costs is the minimum. It is the n value for the smallest total AW of costs.

Market value MV

The estimated amount realizable if the asset were sold on the open market.

Salvage value S

The estimated trade-in or market value at the end of the asset's useful life

Payback period

The payback period np is an estimated time for the revenues, savings, and any other monetary benefits to completely recover the initial investment plus a stated rate of return i.

What does AW of marginal costs equal?

The total AW of costs.

What is the sum of the capital recovery?

The total AW of costs.

What is the fundamental question answered by a replacement study?

Should it be replaced now or later. When not if it should be replaced.

Steps to determine Breakeven Analysis Between Two Alternatives

1. Define the common variable and its dimensional units. 2. Develop the PW or AW relation for each alternative as a function of the common variable. 3. Equate the two relations and solve for the breakeven value of the variable. If the anticipated level of the common variable is below the breakeven value, select the larger slope.

Types of payback analysis.

1. No return; i = 0% (simple payback) 2. Discounted payback; i > 0%

3 Important Rates For Inflation

1. Real interest rate (i). This is the rate at which interest is earned when the effects of changes in the value of currency (inflation) have been removed. Thus, the real inter- est rate presents an actual gain in purchasing power. 2. Market interest rate (if) . The interest rate that has been adjusted to take inflation into account. 3. Inflation rate f. A measure of the rate of change in the value of the currency.

Breakeven Analysis technques

1. Solution by hand 2. Trial and Error 3. Spreadsheet

Fixed Costs

Do not change much with production level (buildings, insurance, fixed overhead, ect)

What does a replacement study determine?

A replacement study determines when a challenger replaces the in-place defender.

What is a replacement study an application of?

A replacement study is an application of the AW method of comparing unequal-life alternatives.

What are used for comparison in replacement study?

AW values.

Sunk cost

An amount of money that has been expended in the past and cannot be recovered now or in the future.

Inflation

An increase in the amount of money necessary to obtain the same amount of goods or services before the inflated price was present.

Breakeven Analysis Between Two Alternatives

Breakeven analysis determines the value of a common variable or parameter between two alternatives. Equating the two PW or AW relations determines the breakeven point. The intersection of the total cost lines locates the breakeven point, and the variable cost establishes the slope.

What does Breakeven Analysis find?

Breakeven analysis finds the value of a parameter that makes two elements equal.

Challenger first cost

Challenger first cost is the amount of capital that must be recovered when replacing a de- fender with a challenger.

Variable Costs

Change with production level (labor, materials, warranty, ect)

What is a defender and a challenger?

Defender and challenger are the names for two mutually exclusive alternatives. The defender is the currently installed asset, and the challenger is the potential replacement.

Defender first cost

Defender first cost is the initial investment amount P used for the defender.

When is replacement study completed?

If the decision is to replace the object or system now.

If no specified period for replacement study?

In a replacement study with no specified study period, the AW values are determined by a technique called the economic service life (ESL) analysis.

What is the fundamental reason for breakeven analysis?

Make or buy decisions.

Marginal costs

Marginal costs (MC) are year-by-year estimates of the costs to own and operate an asset for that year. 3 components 1. Cost of ownership (loss in market value is the best estimate of this cost) 2. Forgone interest on the market value at the beginning of the year 3. AOC for each year

Market value

Market value is the current value of the installed asset if it were sold or traded on the open market. Also called trade-in value.

Purchasing power or buying power

Measures the value of a currency in terms of the quantity and quality of goods or services that one unit of money will purchase. Basically, the value of money decreases so more money is required to buy the same amount of stuff.

NCF

Net cash flows =cash in-cash out

Replacement study procedure.

New replacement study (no study period specified) On the basis of the better AWC or AWD value, select the challenger C or defender D. When the challenger is selected, replace the defender now. One-year-later analysis (study period specified) Develop succession options for D and C using AW of respective cash flows. PW or AW can be used. Select better option (lower value).

How often can a replacement study be performed?

Once a year or more frequently.

Payback analysis reality.

Preferable to use payback as an initial screening method or supplemental tool rather than as the primary means because both no return i and discounted payback disregard all cash flows occurring after the payback period.

Breakeven quantity formula.

QBE=FC/r-v

The two ways a replacement study are determined.

Replacement studies are performed in one of two ways: without a study period specified or with one defined.

Book value BV

Represents the remaining, undepreciated capital investment on the books after the total amount of depreciation charges to date has been subtracted from the basis.

Book depreciation

Used by a corporation or business for internal financial accounting to track the value of an asset or property over its life.

Tax depreciation

Used by a corporation or business to determine taxes due based on cur- rent tax laws of the government entity (country, state, province, etc.). In most industrialized countries, the annual tax depreciation is tax deductible

Replacement or Retention Decisions

Used for a system or object currently in use

Defenders remaining life shorter than study period.

When the defender's remaining life is shorter than the study period, the cost of providing the defender's services from the end of its expected remaining life to the end of the study period must be estimated as accurately as possible and included in the replacement study. This makes no sense

Breakeven Analysis.

When the estimate of one of the engineering economy parameters—P, F, A, i, or n—is not known or the estimate is considered to be inaccurate, a breakeven quantity can be determined by setting an equivalence relation for PW or AW equal to zero.

Known life for challenger or defender.

When the expected life n is known and specified for the challenger or defender, no ESL computations are necessary. Steps 1. Determine the AW over n years 2. Determine the estimated salvage value after n years 3. Determine the AOC

Replacement study for a specified period.

When the time period for the replacement study is limited to a specified study period or planning horizon, for example, 6 years, the ESL analysis is not performed.

Depreciation

is a book method (noncash) to represent the reduction in value of a tangible asset. Annual depreciation amount is not an actual cash flow. It is applied to tangible assets.