Boothe Glassware\'s production floor Is quite large, and a great deal of time an

Question

Boothe Glassware's production floor Is quite large, and a great deal of time and expense goes toward simply transporting work- In-process Inventory from one station to another. Boothe's current conveyor system costs $19,000 per year to operate and Is expected to last another two years. Alternatively, Boothe could buy a new conveyor system for $65,000. The new system would last for eight years and reduce annual operating costs to $7,000. Boothe will want to choose the lowest-cost option. Boothe's opportunity cost of capital Is 9.2%. Should Boothe replace Its existing conveyor system now?

Explanation / Answer

The replacement analysis problem addressed here is, "should the defender asset be replaced now by the challenger asset, which provides equivalent service?" Because the assets provide equivalent service, they are compared solely on the basis of cost. However, it is simple to incorporate variable benefits when that case arises. The techniques discussed are based on two replacement repeatability assumptions, as follows: 1. Challenger assets can be identically replaced when needed in the future. 2. The need for the asset will exist for an indefinite (long) period. The appropriate analysis technique depends on the amount of economic data available for the defender and challenger, and the characteristics of the data, as follows: 1. If defender marginal costs are available, and they increase each year, replace the defender now with the challenger if the defender marginal cost for the next year exceeds the EAC of the challenger over its economic life. Otherwise retain the defender. 2. If defender marginal costs are available, but do not increase each year, replace the defender now with the challenger if the EAC of the defender over its economic life exceeds the EAC of the challenger over its economic life. Otherwise retain the defender. 3. If defender marginal costs are unavailable, the economic life of the defender cannot be calculated. In this case replace the defender now with the challenger if the EAC of the defender over its remaining service life exceeds the EAC of the challenger over its economic life. If marginal costs are also unavailable for the challenger, replace the defender now with the challenger if the EAC of the defender over its remaining service life exceeds the EAC of the challenger over its service life. Otherwise retain the defender.

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