This chapter has presented three distinctly different replacement analysis techniques
which are all relevant and appropriate depending upon the conditions of the cash flows
for the defender and the challenger.In all cases of analysisthe simplifyingreplace..
ment repeatability assumptions are accepted. These state that the defender will ulti-
matelybe replacedby the currentbest challenger(as will any challengersimplemented.
in the future), and that we have an indefinite need for the service of the asset in
question.
In the usual case, marginal cost data are both availableand increasing on a year-to-year
basis, and thus replacement analysis technique 1 allows a comparison ofthe marginal
cost data of the defender, against the minimum EUAC of the challenger.In this case we
should keep the defender as long as its marginal cost is less than the minimum EUAC of
the challenger.
When marginal cost data are available for the defender but are not increasing on a
year-to-year basis, 'replacement analysis technique 2 calls for a comparison ofthe lowest
EUAC of the defender against the minimum EUAC of the challenger.
If the defender's lowest EUAC is smaller, we do not replace it yet. If the challenger's
EUAC is less, we would select this asset in place of the defender today. If the cost "datafor
the challenger and the defender do not change, we will replace the defender after the life
that minimizes its EUAC when its marginal cost data exceed the minimum EUAC for the
challenger.
In the case of no marginal cost data available for the defender, replacement analysis
technique 3 prescribesa comparison ofthe EUACof the defender over its stated life, against
the minimum EUAC of the challenger.
As in the case of replacementanalysis technique2, we would select the alternativethat
has the smallest EUAC.An important concept when calculating the EUAC of both defender
and challenger is the first cost to be assigned to each alternative for calculation purposes.
When the lives of the two alternativesare equivalent,either an opportunity cost or a cash
flow approach may be used. However, in the more common case of different useful lives,
only the opportunity cost approach accurately assigns an investment cost to the defender
and challenger assets.
It is important when performing engineering economic analyses to include the effects
of taxes. In minimum economic life and marginal cost calculations, and in finding cash
flows over the life of a defender or challenger, the effects of taxes can be significant. The
replacement analysis techniques described on a before-tax basis are also used for the after-
tax case-the differencebeing that after-tax cash flowsare used in place of before-tax cash
.flows.Effects on an after-taxbasis include opportunitygains and losses at time zero, income
taxes and depreciation over the assets' lives, and gains and losses at disposition time. The
sign-changeprocedurecan be used to determine opportunity gains and losses when one is
assigning a first cost to the defender in after-tax problems.
Replacement analyses are vastly important, yet often ignored by companies as they
invest in equipment and facilities. Investmentsin business and personal assets s~ould not
be forgotten once an initial economic evaluationhas produced a "buy" recommendation.
It is important to continue to evaluate assets over their respective life cycles to ensure that
invested monies are continuing to yield the greatest benefit for the investor. Replacement
analyses help us to ensure this.
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(^430) REPLACEMENT ANALYSIS
