Replacement Analysis Questions and Answers

Answer: A

Correct answer: asset currently in service

The defender is the incumbent, and the challenger is the proposed replacement. The terms matter because the two are not treated alike: the defender’s investment is its current market value, not its original cost, while the challenger’s is what must actually be paid for it.

Answer: B

Correct answer: obsolescence

An asset can become uneconomic without wearing out at all, simply because something better now exists or because what the business needs has changed. Obsolescence is often the dominant reason for replacement in fast-moving technology, where a perfectly serviceable machine is displaced by a more efficient one.

Answer: C

Correct answer: newcomer to the business would pay for each asset

The outsider viewpoint is a device for stripping out sentiment and history. Someone entering the business fresh would pay the market value for the existing asset and the purchase price for the new one, and would compare the two on future costs alone - which is exactly the comparison the analysis should make.

Answer: D

Keeping the asset means forgoing the money a sale would realise, so that forgone receipt is precisely what retention costs. The original cost is sunk and the book value is an accounting figure with no economic content of its own.

Answer: A

Correct answer: sunk and unaffected by the present decision

The money has gone and no decision now can retrieve it. Since the original cost is identical whether the asset is kept or replaced, it cannot distinguish between the alternatives and must be left out. What is relevant is the market value, because that is what keeping the asset actually forgoes.

Answer: B

Correct answer: the tax on any gain or loss on disposal

Book value has no economic meaning of its own - it is an accounting figure - but it determines the taxable gain or loss when the asset is sold, and that tax is a real cash flow. So book value enters the analysis at one remove, through the tax computation, and nowhere else.

Answer: C

Correct answer: trying to recover past expenditure through the present decision

The trap is the reasoning that runs “we have too much invested in this machine to scrap it now”. Keeping an uneconomic asset does not recover the money already spent; it merely adds further losses to it. The past expenditure is identical under either course and therefore cannot bear on the choice.

Answer: D

Calculating the equivalent annual cost for each possible retention period and taking the smallest gives the economically best life. It is generally shorter than the physical life and rarely coincides with the life used for tax.

Answer: A

Correct answer: falls

Capital recovery spreads the initial investment less the salvage over the years of service, so the more years there are the smaller the annual share. This is the force pulling towards keeping an asset longer, and it is opposed by the operating cost, which pulls the other way.

Answer: B

Correct answer: rises

Maintenance grows as parts wear, breakdowns become more frequent, efficiency falls and downtime increases. This is the force pulling towards earlier replacement, and the balance between it and the falling capital recovery is what produces an economic life at all.