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Further aspects of investment appraisal

4.2 Optimum replacement cycles

 Companies purchasing new plant and machinery must decide how often to
replace them. Factors in replacement decisions include

 Capital cost of new equipment

 Operating costs

 Resale value

 Taxation and investment incentives

 Inflation.

Step 1: Consider each possible replacement cycle in turn: 1 year,
2 year, 3 year etc.

Step 2: Calculate the PV of costs for each cycle.

Step 3: Divide this PV by the annuity factor to find the equivalent
annual cost.

Step 4: Select the replacement cycle with the lowest equivalent

annual cost.

Illustrations and further practice

Now attempt example 10 ‘Supermarket delivery vehicles’ from Chapter 11.

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