Sunday, October 3, 2021 8:18 AM
▶ REPLACEMENT STUDIES
The Four Major Reasons for Replacement
Physical impairment
The existing asset is completely or partially worn out and will no longer function satisfactorily
without extensive repairs.
Inadequacy
The existing asset does not have sufficient capacity to meet the present demands that are placed
on it.
Obsolescence
This may be caused either by lessening in the demand for the service rendered by the asset or the
availability of more efficient assets that will operate with lower out-of-pocket costs.
Rental or lease possibilities
It is possible to rent identical or comparable assets or property, thus freeing capital for other and
more profitable use.
Sunk Cost Due to Unamortized Value
The unamortized value of equipment or property is the difference between its book value and its
resale value when replaced. The unamortized value should be considered as a sunk cost or a loss.
Basic Patterns for Replacement Studies
Replacement economy studies may be made by any of the basic procedures or patterns which
have been discussed previously. However, in most cases either the rate of return method or
the annual cost method is used.
Module-6 Page 1
Sunday, October 3, 2021 9:14 AM
An existing factory must be enlarged or replaced to accommodate new production machinery.
The structure was built at a cost of P2.6 million. Its present book value based on straight-line
depreciation is P700,000 but it has been appraised at P800,000. If the structure is altered, the cost
will be P1.6million and its service life is extended 8 years with a salvage value of P600,000. A new
factory could be purchased or built for P5 million. It would have a life of 20 years and a salvage
value of P700,000. Annual maintenance of the new building would be P160,000 compared with
P100,000 in the enlarge structure. However, the improved layout in the new building would
reduce the annual production cost by P240,000. All other expenses for the new structure are
estimated as being equal. Using an investment rate of 8%, determine which is the more attractive
investment for this firm.
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Sunday, October 3, 2021 9:14 AM
A decision must be made whether to replace a certain engine with a new one, or to rebore the
cylinder of the old engine and thoroughly reconditioned it. The original cost of the old engine 10
years ago was P70,000, to rebore and recondition it now will cost P28,000 but would extend its
useful life for 5 years. A new engine will have a first cost of P62,000 and will have an estimated
life of 10 years. it is expected that the annual cost of fuel and lubricants with the reconditioned
engine will be about P20,000 and that this cost will be 15% less with the new engine. It is also
believed that repairs will be P2,500 a year less with the new engine than the reconditioned one.
Assume that neither engine has any net realizable value when retired. If money is worth 16%,
what would you recommend?
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Sunday, October 3, 2021 9:15 AM
▶ BREAK-EVEN ANALYSIS
In engineering economy, many situations are encountered where the cost of two or more
alternatives may be affected by a common variable.
Break-even point is the value of the variable for which the costs for the alternatives will be
equal
TO BREAK-EVEN:
Total Sales = Total Expenses
PROFIT:
Profit = Total Sales - Total Expenses
Break-Even Chart
The Break-even chart is a graphical representation of break-even analysis. The break-even point
is the quantity of production at which the income is equal to the total cost. It is the intersection
of the income line and the total cost line on the break-even chart.
This is the break-even chart for business enterprises.
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Sunday, October 3, 2021 9:16 AM
A company manufacturing calculator has a capacity of 200 units a month. The variable costs are
P1,000 per unit. The average selling price of the calculators is P2,500. Fixed costs of the
company amount to P150,000 per month, which include all taxes.
(a) Determine the number of calculators that must be sold each month to break-even.
(b) What is the profit or loss if 150 units were produced and sold per month?
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Sunday, October 3, 2021 9:17 AM
A company which manufactures electric motors has a production capacity of 200 motors a
month. The variable cost are P 150.00 per motor. The average selling price of the motors is P
275.00. Fixed cost of the company amount to P 20,000 per month which includes taxes. The
number of motors that must be sold each month to break-even is closest to? What will be the
profit if company operates full capacity?
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