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Www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 1 Replacement Basics.

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Presentation on theme: "Www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 1 Replacement Basics."— Presentation transcript:

1 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, Replacement Basics

2 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Chapter 11 Replacement Decisions Replacement Analysis Fundamentals Economic Service Life Replacement Analysis When a Required Service is Long Replacement Analysis with Tax Consideration

3 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Replacement Terminology Sunk cost: any past cost unaffected by any future decisions Trade-in allowance: value offered by the vendor to reduce the price of a new equipment Defender: an old machine Challenger: a new machine Current market value: selling price of the defender in the market place

4 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Sunk Cost associated with an Assets Disposal $0 $5000 $10,000 $15,000 $20,000 $25,000 $30,000 Original investment $10,000$5000 Market value $10,000 Lost investment (economic depreciation) Repair cost $20,000 Sunk costs = $15,000

5 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Replacement Decisions Cash Flow Approach Treat the proceeds from sale of the old machine as a down payment toward purchasing the new machine. Opportunity Cost Approach Treat the proceeds from sale of the old machine as the investment required to keep the old machine.

6 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Example 11.2 Replacement Analysis – Cash Flow Approach $8000 $2500 $15,000 $6000 $5500 (a) Defender(b) Challenger $10,000 Sales proceeds from defender

7 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Annual Equivalent Cost - Cash Flow Approach Defender: PW(12%) D = $2,500 (P/F, 12%, 3) - $8,000 (P/A, 12%, 3) = - $17, AE(12%) D = PW(12%) D (A/P, 12%, 3) = -$7, Challenger: PW(12%) C = $5,500 (P/F, 12%, 3) - $5,000 - $6,000 (P/A, 12%, 3) = -$15, AE(12%) C = PW(12%) C (A/P, 12%, 3) = -$6, Replace the defender now!

8 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Example 11.3 Opportunity Cost Approach $8000 $2500 $15,000 $6000 $5500Defender Challenger $10,000 Proceeds from sale viewed as an opportunity cost of keeping the old asset

9 Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, of 52 Defender: PW(12%) D = -$10,000 - $8,000(P/A, 12%, 3) + $2,500(P/F, 12%, 3) = -$27, AE(12%) D = PW(12%) D (A/P, 12%, 3) = -$11, Challenger: PW(12%) C = -$15,000 - $6,000(P/A, 12%, 3) + $5,500(P/F, 12%, 3) = -$25, AE(12%) C = PW(12%) C (A/P, 12%, 3) = -$10, Opportunity Cost Approach Replace the defender now!


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