Question

Please explain the final answer.

A material handling system was purchased 3 years ago for $123,816. Two years ago it required substantial upgrading at a cost of $16,340. It once again is requiring an upgrading cost of $24,254. Alternately, a new system can be purchased today at a cost of $200,688, with a salvage value of $19,120. The existing machine could be sold today for $49,996.

In an economic replacement analysis, what first cost should be assigned to the existing system?

Answer 1

Replacement analysis is technique of capital budgetting. In replacement analysis existing equipment called defender and new equipment called challenger are evaluated based on the present value annual net cash flow over the term of both the machines to analysis whether to continue with defender or replaced with challenger.

In replacement analysis, first cost to be assigned to existing system is upgradation cost of $24,254 which is required today as all past incurred cost are not relevant to current decision making. Cash flows to be compared today are-

Existing machine inflow= ($24,254)

New machine inflow= ($200,688)+49,996