Carried out

when there
is a need to

REPLACEMENT replace or
augment the
currentl y
ANALYSIS owned
equipment
(or any
asset).
REPLACEMENT ANALYSIS PROCEDURE

1. Find cash flow differentials between the

new and old projects.

2. Analyse the incremental cash flows.

ILLUSTRATION
Data applicable to both machines:
Sales, which would remain constant $ 2,500
Expected life of the old & new machines 4 years
WACC for the analysis 10%
Tax rate 40%

Data for old machine:

Salvage value of the old machine $ 400
Materials, labor, and other costs per year $ 1,000
Depreciation $ 100

Data for new machine:

Cost of the new machine $ 2,000
Materials, labor, and other costs per year $ 400
 CRITERIA

−1600 584 680 440 376

NPV = + + + + = $80.28
1.10 0 1.10 1 1.10 2 1.10 3 1.10 4

Year Inflow Accu. Inflow

1 584
1600 − 1264 336
2 680 1264 2; = = .76
440 440
3 440 1704
Payback period = 2.76
4 376 2080
 A risk analysis
technique in
which “bad”
and “good”
sets of

SCENARIO ANALYSIS financial

circumstances
are compared
with a most
likely, or base
case,
situation.
 SCENARIOS

Base-Case Scenario
An analysis in which all of the input variables are set at their most
likely values.

Worst-Case Scenario
An analysis in which all of the input variables are set at their worst
reasonably forecasted values.

Best-Case Scenario
An analysis in which all of the input variables are set at their best
reasonably forecasted values.
ILLUSTRATION
 MONTE CARLO SIMULATION

 Analysis that grew out of work on the mathematics of casino

gambling.

 The project analysed under a large number of scenarios, or

“runs”.

 In ever y run, the computer randomly picks a value for each

variable.

 Variables are used to calculate the NPV.

 The mean of the 1 ,000 NPVs is used as a measure of the

project’s expected profitability

 The standard deviation of the NPVs is used to measure risk .