REPLACEMENT  ANALYSIS 

REPLACEMENT ANALYSIS :-

Replacement analysis is a systematic assessment by a buisness of the need to replace its existing asset/assets and taking appropriate decisions there on , with the objective of maintaining / improving its financial performance.

When a machine is going to replace the old machine is known as "Defender" and the new machine are known as "Challenger". If  Challenger proves the most economical in term of cost capacity, efficiency, speed of technology, and many other factors , then challenger should be accepted.

REASONS FOR REPLACEMENT :-

Reasons for replacement are as follows :-

PHYSICAL DETERMINATION :- When a asset is put to use the value of such asset may decrease. This decrease in the value of asset is said to be due to physical wear and tear or physical deterioration. Once this type of deterioration sets in , it lead to increased maintenance repair cost on a regular basic and greater energy requires frequently.

It is not possible to get rid of it , though it may be possible to slow down it.

ALTERED REQUIREMENT :- It is observed that sometime the existing production capacity of a firm is insufficient - for meeting the market demand and in this very time alternative is required to replace.

OBSOLESCENCE :- When a new technology capture market and on the account of that existing assets losses it value is known as obsolescence.

FINAL CONSIDERAION :- NO Decision relating to replacement of an asset is justified unless it meets strict criteria of financial soundness .For example , where taking an asset on rental basis is better than owing , a large no. of business man prefer taking business accommodation on rent rather than owning.

ADDITIONAL CONSIDERATIONS :- Business has a social and ethical responsibility it is a additional consideration to a business which lead a business to replace a asset. for example - the assets which create pollution or make depletion of non-renewable asset , should be replaced.

MARGINAL COST :- Marginal cost in a replacement decision means the aggregate of operating and maintenance cost and capital recovery cost.

Operational cost :- Expenses of keeping an asset in active service.

Maintenance cost :- Expenses of keeping an asset in operative condition.

Capital Recovery cost :- Aggregate Capital recovery cost for n years is (P-Sn) where 

p = Purchase price or capital cost or initial cost and 

Sn = Salvage value market value of the asset at the end of n years of its use.

MINIMUM COST LIFE OF A NEW MACHINE :-

Minimum cost life of a new asset means number of years at which the average annual cost (AAC) is minimum. It is also called optimum life cost or Economic life cost. Due to the increasing repair maintenance and operating cost of a machine the minimum cost life may be shorter than the expected life of a machine. When time value of money is considered the present value of repair and maintenance cost are to be analyzed for each year and average annualized cost for different years are also determines.

The rule is -

If average annualized cost > next period's cost - Replacement is not made.

If average annualized cost < next period cost - Replacement is made.

where average annualized cost =total cost / cummulative discount factor or (no. of years)