Unamortized value of existing property---do not play any role in replacement study based on ROR from Replacement decision — based necessary investment Amount of investmen investmentt should be considered considered Necessary Investment = (Total cost of replacement property) – (Net realizable value of existing property) property)
Net
Realizable Value For replacement study, net realizable value should be assumed to be market value This value may be < actual value of property, property, it still represents amount of capital which can be obtained from old equipment if replacement is made Attempt to assign an existing property a value greater than net realizable value tends to favor replacements which are uneconomical
1
Compiled by Prof. Prasad Parulekar
Analysis
of Common Errors made in Replacement Studies Failure to realize that replacement analysis should be based on present time conditions New ventures, sometimes are forced to pay off losses incurred in past due to past mistakes Including unamortized value as an addition to Replacement Investment--- one of the most common error; increase apparent economical; error sometimes included in determining depreciation for replacement Unamortized value must be considered as dead loss (or gain) due to incorrect depreciation accounting in past
2
Compiled by Prof. Prasad Parulekar
Use
of Book Value for Old Equipment in Replacement Studies This error occurs --- due to refusal to admit mistakes in past during depreciation evaluation evaluation Making this error means justifying that continued operation of present equipment would eventually permit complete depreciation ----- totally unrealistic----competitive situation in modern business is not considered Business concerns operating with good profits with lowest price remain in business and force other competitors either to reduce their profit or shut down operation Result of using book value in replacement studies – apparent cost of existing property property are usually greater than they should be; apparent capital outlay for replacement is reduced
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Compiled by Prof. Prasad Parulekar
Practical
Factor in Alternative Investment & replacement Studies Available capital is limited---- advisable to select alternative with smallest investment giving necessary service and acceptable return as compared to greater investment which might be better on theoretical basis, but additional return will not be worth extra risk involved when capital must be borrowed from outside source Accuracy of estimations used in determining determining ------ theoretically sound investment, might ROR -----not be accepted as service life used in determining depreciation cost appears to be too long; all risk factors should be considered before accepting investment greater than that absolutely necessary Existing economic conditions at particular time ------ when economic conditions are uncertain , should think carefully before making investment greater than that absolutely necessary; also tax situations have to be considered considered Certain intangible factors ---- expenses for external appearance of property or for some unnecessary treatment to final product ---just to impress the customers--- these advertising benefits may not have consideration in theoretical economic analysis but definitely influence management’s final decision in selecting best investment investment Certain other practical factors------ personal prejudice; desire to better a competitor’s competitor’s production
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Compiled by Prof. Prasad Parulekar
rate or standards; availability of excess capital; urges to expand existing plant
