Engineering Economy Lecture 7 (Sept 22) Problem #3

Replacement Studies Four year ago, a ore-crushing unit was installed at a mine
which cost P81,000. Annual operating cost for this unit
4 Major Reasons for Replacement are P3,540. This unit was estimated to have a life of 10
1. Physical Impairment years. The quantity of ore to be handled is to be doubled
2. Inadequacy and is expected to continue at this higher rate for at least
3. Obsolescence 10 years. A unit that will handle the same quantity of ore
4. Rental or Lease Possibilities and have the same operating costs as the one now in
service can be installed for P75,000. This unit will have a
Sunk Cost Due to Unamortized Value (UV) useful life of 6 years.
-UV of an equipment or property is the difference A unit double the capacity of the one now in use can be
between its book value and its resale value when installed for P112,000. Its life is estimated at 6 years and
replaced. Unamortized value its annual operating costs are estimated at P4,950. The
present realizable value of the unit now in use is P26,000.
Basic Patterns for Replacement Studies All units under consideration will have an estimated
-most cases ROR and AW salvage value at retirement age of 12% of the original
cost. Interest rate is 20%. Annual taxes and insurance are
Problem #1 2.5% of the original cost. What would you recommend?
An existing factory must be enlarged or replaced to
accommodate new production machinery. The structure Problem #4
was built at a cost of P2.6 million. Its present book value A car can be purchased new for P600,000 when new.
based on straight line depreciation is P700,000 but it has There follows a schedule of annual operating expenses
been appraised at P800,000. If the structure is altered, the for each year and trade-in values at the end of each year.
cost will be P1.6 million and its service life will be Assume that these amounts would be repeated for future
extended 8 years with a salvage value of P600,000. replacements, and that the car will not be kept more than
A new factory could be purchased or built for P5million. 3 years. If interest on invested capital is 15% before
It would have a life of 20 years and a salvage value of taxes, determine at which year’s end the car should be
P700,000. Annual maintenance of the new building replaced so that costs will be minimized.
would be P160,000 compared with P100,000 in the
enlarged structure. However, the improved layout in the Year 1 Year 2 Year 3
new building would reduce annual production cost by Operating expenses P34,000 P38,000 P41,000
P240,000. All other expenses for the new structure is for year
estimated as being equal. Using an investment rate of 8%, Trade-in value at 408,000 336,000 240,000
determine which the more attractive investment for this end of year
firm is.
Problem #5
Problem #2 A recapping plant is planning to acquire a new Diesel
A decision must be made whether to replace a certain generating set to replace its present unit which they run
engine with a new one, or to rebore the cylinder of the during brownouts. The new set would cost P135,000 with
old engine and thoroughly recondition it. The original a five (5) year life and no estimated salvage value.
cost of the old engine 10 years ago was P70,000; to Variable cost would be P150,000 a year.
rebore and recondition it now will cost P28,000, but The present generating set has a book value of P75,000
would extend its useful life for 5 years. and a remaining life of 5 years. Its disposal value now is
A new engine will have a first cost P62,000 and will and P7,500, but it would be zero after 5 years. Variable
estimated life of 10 years. It is expected that the annual operating cost would be P187,500 a year. Money is worth
cost of fuel and lubricants with the reconditioned engine 10%.
will be about P20,000 and this cost will be 15% less with Which is profitable, to buy a new generator set or retain
the new engine. It is also believed that repairs will be the present set? Support your answer via a computation.
2,500 a year less with the new engine than with the
reconditioned one. Assume that neither engine has any (Ans: 9.82%, 31051 vs 29828, 19266 vs 17676, 316000
net realizable value when retired. If money is worth 16%, vs 307385 vs 272851) Note that these ain’t answers buy
what would you recommend? clues.