Engineering Economic Analysis

l

420 REPLACEMENT ANALYSIS

technological advances in assets targeted for replacement. This part of the decision process

is much like the search for all available alternatives,from which we select the best. Upon

finding out more about what alternatives and technologies are emerging, we will be better

able to understand the repercussions of investing in the current best available challeng~r.

Selecting the current best challenger asset can be particularly risky when (l) the costs

are very high and/or (2) the useful minimum cost life of that challenger is relatively long

(5-10 years or more). When one or both of these conditions exist, it may be bette~to keep

or even augment our defender asset until better future challengers emerge.

There are, of course, many assumptions thatcouldbe made regarding future chal-

lengers. However, if the replacement repeatability assumptions do not hold, the analysis

techniques described earlier may not be valid.

AFTER-TAX REPLACEMENT ANALYSIS

As described in Chapter 12, an after-tax analysis adds an expandedperspective to our prob-

lems because various very important effects can be included.We saw earlier that eXamining'

problems on an after-tax basis provides greater realism and insight. This advantage also

exists when one is considering the replacement problems discussed in this chapter. Tax

effects have the potential to alter recommendations made in a before-tax-only analysis.

After-tax effects may influence calculations in the remaining economic life of defender,

in the economic life of challenger, and in the defender-challenger comparisons discussed

earlier. Consequently, one should always perform these analyses on an after-tax basis. In

this section we illustrate the complicating circumstances that are introduced by an after-tax

analysis.

Marginal Costs on an After-Tax Basis

As in the before-tax case, the defender-challenger comparison is sometimes based on the

marginal costs of the defender on a year-to-yearbasis. Marginal costs on an after-tax basis

represent the cost that would be incurred through ownership of the assetin each year.On

an after-tax basis we must consider the effects of ordinary taxes as well as gains and losses

due to asset disposal in calculating the after-tax marginal costs. Consider Example 13-10.

Refer to Example 13-2, where we calculated the before-tax marginai costs for a new piece

II of production machinery. Before-:tax~ual ,cost infonp.ation was given, as well as year'"en.d

" salvagevaluesfor theassetbverits usefullife.Calculatethe after-taxD;1argimilcostsof thisasseta

consid~ringthe additionalinformationbelqw.

·D~p.rechltion.is by ~e stfatght-line'method, with S ,$0 imdn ,5ye¥8.

,. Ordinary"incoine:1s ta:xe1i~at""aTate~Q~~40%.:= ::~ i:.o=:~~ -= r.;,;;: = r;;1:1:;;;':1 I!O:II::;;=."""

· Assume that all gains and IQssesare t(lxedat a tate of 28%.. ,.,. " 110"

~ The after.,tax.~MARR is 10%~ ..'- -< -- - &a= ... -. - -.- ===_ -: ~_~

II

III.

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