Replacement Economics for a Working Conveyor Drive
A plant's main conveyor drive is 12 years old and still running. Its market value today is $8,000 and it will have no salvage value in three years, when the conveyor frame is due for replacement anyway. Operating and maintenance cost is $26,000 this year and has been escalating about $3,000 per year. A replacement drive costs $60,000 installed, would last 8 years with a $6,000 salvage value, and would cost $14,000 in its first year, escalating about $1,500 per year. The MARR is 12% and capital is available. Separately, a contract under negotiation could cut plant throughput by 30% within two years. The maintenance superintendent argues for waiting, because the old drive is 'already paid for' and the new drive's savings are only a few percent.
1. Perform an equivalent uniform annual cost comparison and state the annual advantage of the better alternative.
Read the worked answer
Factors at i = 12%: (A/P,12%,3) = 0.41635; (A/P,12%,8) = 0.20130; (A/F,12%,8) = 0.08130; (A/G,12%,3) = 0.9246; (A/G,12%,8) = 2.9131.
Keep the old drive (3-year horizon)
- Capital recovery of the opportunity cost: 8,000 x 0.41635 = $3,331
- First-year O&M: $26,000
- Escalation: 3,000 x 0.9246 = $2,774
- EUAC_old = $32,105/yr
Buy the new drive (8-year horizon)
- Capital recovery: 60,000 x 0.20130 - 6,000 x 0.08130 = 12,078 - 488 = $11,590
- First-year O&M: $14,000
- Escalation: 1,500 x 2.9131 = $4,370
- EUAC_new = $29,960/yr
Advantage of replacing: $32,105 - $29,960 = about $2,145/yr, roughly 6.7% of the old drive's annual cost.
The comparison is valid because both EUACs are expressed per year of service over their own lives, and the old drive's remaining life is set by the frame replacement, not by the drive itself. Two cautions on method: (a) the $8,000 market value is correctly charged as a capital cost - keeping the drive means forgoing the sale, so it is an opportunity cost, not a free asset; and (b) the old drive's $0 book value is irrelevant and must not appear anywhere in the calculation.
2. Respond to the superintendent's 'already paid for' argument, and say whether $2,145/yr is enough to act on.
Read the worked answer
The argument is a sunk-cost fallacy. What the drive cost 12 years ago is gone and cannot be recovered by any decision made today. The only numbers that matter are the ones that differ between the two futures: the $8,000 you would give up by keeping it, the O&M each option will incur from here, and the salvage at the end. If the new drive's EUAC is lower, keeping the old drive destroys value every year, regardless of how long it has been owned.
Is $2,145/yr enough? Not on its own - and the honest answer is that this is a marginal call, not a slam dunk. Reasons to be cautious:
- The margin is ~6.7% of the old drive's annual cost, well inside the error band of the O&M escalation estimates. If the old drive's escalation is $2,500/yr rather than $3,000, the gradient term falls to $2,312 and EUAC_old drops to $31,643 - the advantage halves to about $1,680. The decision is sensitive to a number nobody has verified.
- Neither EUAC includes the cost of the changeover itself: installation downtime on the main conveyor, temporary manual handling, and the possibility of a commissioning period at reduced throughput. If installation costs two days of lost production, the first year's saving is consumed outright.
- The old drive's remaining life is dictated by the frame, so the comparison silently assumes the new drive's service can be repeated or that the frame replacement at year 3 will not strand an 8-year asset. Verify that the new drive can be carried over to the new frame; if it cannot, the effective life is 3 years and the EUAC rises sharply.
Recommendation: replace, but treat it as a project rather than a purchase - schedule the installation into a planned shutdown, verify the escalation figure against the last three years of maintenance invoices, and confirm drive compatibility with the year-3 frame. If any of those checks fails, deferral is defensible.
3. How far could throughput fall before replacement stops being justified? Show the calculation.
Read the worked answer
Scale both O&M streams by the same fraction x, since variable O&M tracks volume, and hold the capital recovery terms fixed.
Annual O&M EUACs at 100% volume
- Old: 26,000 + 2,774 = $28,774
- New: 14,000 + 4,370 = $18,370
- Saving = 28,774 - 18,370 = $14,404/yr
Capital recovery difference
- New CR $11,590 - Old CR $3,331 = $8,259/yr
Break-even: 14,404 x = 8,259 -> x = 0.573
So the replacement stays justified only while throughput stays above about 57% of today's level - a 43% drop, not the 30% currently on the table.
Check at the 30% cut (x = 0.70):
- Old: 0.70 x 28,774 + 3,331 = 20,142 + 3,331 = $23,473
- New: 0.70 x 18,370 + 11,590 = 12,859 + 11,590 = $24,449
At 70% of current volume the old drive wins by about $976/yr. The reason is structural: the new drive's advantage is mostly operating savings, which shrink with volume, while its disadvantage is capital recovery, which does not. Also note the escalation gradient works against the new drive on a per-year basis ($4,370 vs $2,774) - the new drive's absolute O&M grows faster, which matters more, not less, at low volume.
What to do with this:
- Do not sign the drive purchase until the contract outcome is known, if that can be held for a few weeks. This is a genuinely reversible decision and the information is cheap to wait for.
- If the drive must be ordered now for other reasons (reliability, spare-part obsolescence), size the justification on the downside case, not the base case, and say so in the appropriation request.
- Set a documented trigger: if the contract is signed and throughput is confirmed below ~57%, cancel the replacement and re-run the analysis with the actual operating plan.