Depreciation replacement value

It is difficult to predict future market values or replacement values with a high degree of accuracy because of fluctuations in market demand and price conditions. On the other hand, a future book value can be predicted with absolute accuracy as long as a constant method for determining depreciation costs is used. It is quite possible for the market value, replacement value, and book value of a property to be widely different from one another because of unrealistic depreciation allowances or changes in economic and technological factors. 

Aftor Tax Balance Depreciation + Salvage Value of Replacement Heater S 23,500... 

All of the depreciation methods to be discussed are based on the asset book value, which at any year is defined as the original cost of the asset (e.g., the depreciable capital investment) minus the sum of the depreciation charges made to the asset up to that year. This is in contrast to the market value, which is the price that could be obtained for the asset if it were placed for sale in the open market, and the replacement value, which is the cost of replacing the asset. The book value is the value shown on the accounting records. The book value decreases each year until it reaches a salvage value, at which time it is completely depreciated. The number of years, n, over which an asset can be depreciated is usually related to an estimate of the useful life of the asset, which is discussed below. 

The cost of replacing property without a reduction for depreciation. By this method of value determination, damages for an insurance claim would be the amount needed to replace the property using new materials. Replacement cost refers to the amount that an entity would have to pay to replace an asset at the present time. This may not be the market value of the item. Replacement cost coverage is designed so the policyholder will not have to spend more money to get a similar new item and so that the insurance company does not pay for intangibles. May also be called replacement value. 

Inflationary Effects. Inflation can have a significant effect on the profitabiUty of a venture. However, the U.S. federal tax laws do not allow for indexing the inflationary effects on depreciation schedules, salvage values, replacement costs, or taxable income. Inflation rates can vary unpredictably with time and can differ for certain revenues of expenditures. 

Replacement of the steam-jet ejector with a vacuum pump. The distillation operation will not be affected. The operating cost of the ejector and the vacuum pump are comparable. However, a capital investment of 75,000 is needed to purchase the pump. For a five-year linear depreciation with negligible salvage value, the annualized fixed cost of the pump is I5,000/year. 

Certain terminology has been developed to identify the equipment under consideration. The item in place is called the defender, and the candidate for replacement is called the challenger. This terminology and methodology was reported by E. L. Grant and W. G. Ireson in Engineering Economy, Wiley, New York, 1950. To apply this method, there are certain rules. The value of the defender asset is a sunk cost and is irrelevant except insofar as it affects cash flow from depreciation for the rest of its life and a tax credit for the book loss if it is... 

A proposal has been made to replace the present piece of property by one of more advanced design. The proposed equipment would cost 40,000, and the operating costs would be 15,000/year. The service life is estimated to be 10 years with a nonzero salvage value. Each piece of equipment will perform the same service, and all costs other than those for operation and depreciation will remain constant. Depreciation costs are determined by the straight-line method. The company will not make any unnecessary investments in equipment unless it can obtain an annual return on the necessary capital of at least 10 percent. 

INCLUDING UNAMORTIZED VALUE AS AN ADDITION TO THE REPLACEMENT INVESTMENT. This is one of the most common errors. It increases the apparent cost for the replacement and tends to prevent replacements which are really economical. Some persons incorporate this error into the determination of depreciation cost for the replacement equipment, while others include it only in finding the investment on which the rate of return is based. In any case, this method of attempting to account for unamortized values is incorrect. The unamortized value must be considered as a dead loss (or gain) due to incorrect depreciation accounting in the past. 

USE OF BOOK VALUE FOR OLD EQUIPMENT IN REPLACEMENT STUDIES. This error is caused by refusal to admit that the depreciation accounting methods used in the past were wrong. Persons who make this error attempt to justify their actions by claiming that continued operation of the present equipment would eventually permit complete depreciation. This viewpoint is completely unrealistic because it gives no consideration to the competitive situation existing in modem business. The concern which can operate with good profit and still offer a given product or service at the lowest price can remain in business and force competitors either to reduce their profits or to cease operation. 

The new unit would cost 70,000 and would result in an increase of 5000 in the gross annual income. It would permit a labor saving of 7000 per year. Additional costs for taxes and insurance would be 1000 per year. The service life is estimated to be 12 years with a final salvage value of 1000. All costs other than those for labor, insurance, taxes, and depreciation may be assumed to be the same for both units. The old unit can now be sold for 5000. If the minimum required return on any investment is 15 percent, should the replacement be made ... 

The annual cost of equipment includes depreciation and maintenance. In addition, an allowance should be made for the loss of interest which, if the instrument had not been purchased, would have accrued from investment of the capital. Depreciation is the difference between the capital cost and the secondhand value. In practice, the secondhand value of an instrument is usually small, not because it is worn out, but because there are newer and better instruments available for performing the same task. Few instruments cannot be replaced by faster and better ones after 5 years, although many continue to be used for long after this time despite progressively increasing maintenance costs. This built-in obsolescence makes rental attractive as this enables the user to change his instrument quickly without loss of capital it may also act as an incentive to manufacturers to improve their maintenance service. 

As a starting point, in World I, a range of single values for replacement life in years was assigned by B.C.L. to each capital-producing sector on the basis of U.S. Internal Revenue Service data for depreciation rates. These replacement lives provided a useful starting point, although the replacement lives did not represent actual lives in service. 

Example 1. A company proposes to invest 500000 this year in a plant to make a speciality chemical on a scale of 500 tonnes/year. Working capital is estimated to be 100000 at full output and would be spent proportionally to output. Sales are forecast as 300 tonnes in year 1 rising to 400 tonnes and 500 tonnes in subsequent years. Product market life is expected to be five years before being replaced. A scrap value of 100000 is expected for the plant after shutdown. The variable cost of the product is 350/tonne and fixed costs are 155 000/year. Depreciation allowance and tax rate are 52% payable one year in arrears and sales income is 1100/tonne. The company needs a 15% return is the project viable What is the DCF rate ... 

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