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Understanding Economic Life
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Today, we're discussing the **economic life of a machine**. Can anyone tell me what they think that means?
Does it mean the time we're supposed to use it before it costs us more money?
Exactly! The economic life is the period where owning the machine is most cost-effective. Beyond that, costs go up. We call this the period when holding the machine incurs minimal costs.
What costs are we talking about?
Good question! The costs include maintenance, downtime from repairs, and obsolescence due to older technology. When we think about these factors, we should look for efficient replacement times.
So, if we keep a machine longer than its economic life, we lose money?
That's right! To remember this, think of it as the 'Eagle's Eye' - you want to see beyond the immediate costs to avoid losses!
In summary, the economic life is critical for maintenance cost management, making replacements strategic rather than reactive.
Calculating Replacement Costs
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Now, let's talk about **replacement costs**. How do you think we can estimate the costs associated with replacing a machine?
Maybe by looking at how much it costs to maintain and any depreciation?
Exactly! We start with depreciation, then consider the costs of maintenance, downtime, and investment. Permanent costs evolve as a machine ages.
How do we calculate depreciation?
Great question! We use methods like the **Double Declining Balance** for depreciation. It helps us assess how value decreases over time. For example, after the first year, the depreciation might be ₹8,75,000 for our shovel.
What about the costs in the following years?
We follow through for each year. These figures show cumulative impacts on costs. Think of it as 'layering' costs over time, like building a cake!
The key points to remember: calculate depreciation annually and recognize how costs accumulate over time. Understanding this makes predicting replacement conditions clearer.
Analyzing Total Ownership Costs
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Next, let's analyze the **total costs of ownership**—what does that involve?
Isn't it just the purchase price of the machine?
Not quite! We need to include maintenance, repair costs, and downtime too. All these factors together give us a clear picture of total ownership costs.
What if those costs increase with the machine's age?
Exactly! Maintenance and repair costs generally rise as machines age. It's essential to monitor these trends to understand when to replace.
Is there a way to calculate this for real?
Absolutely! For our shovel, we can determine costs hourly and analyze them to decide optimal lifecycle timing. Think of it like figuring out the best route on a map—it helps us navigate through replacements wisely!
So, remember, total ownership costs include all facets of using the machine over its lifetime—not just the initial purchase.
Introduction & Overview
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Quick Overview
Standard
In this section, we delve into the concept of economic life, which refers to the optimal time to hold a machine before replacement due to increasing maintenance, downtime, and obsolescence costs. Various calculations, including depreciation, repair costs, and investment costs, are discussed, providing a framework for conducting a thorough replacement analysis.
Detailed
Detailed Summary
In this section, we explore the concept of economic life of machinery, emphasizing that it represents a period where the total costs associated with the machine are minimized. Beyond its economic life, costs such as maintenance, downtime, and obsolescence increase, leading to disadvantages for the owner.
Key Concepts:
- Economic Life: The time span during which holding a machine incurs minimal costs.
- Increasing Costs: As machines become older, costs rise due to factors such as repairs, extended downtime, and technological obsolescence.
- Replacement Analysis: To prevent losses, it's prudent to replace older machines with new ones as they surpass their economic life.
Example Calculation:
An example is provided involving a track-mounted front shovel with a purchase price of ₹35,00,000. The following details are pivotal:
- Depreciation Method: Double declining balance
- Useful Life: 8 years
- Salvage Value: ₹7,00,000
- Inflation Rate: 6% annual increase in equipment cost
- Investment Cost: 15% per year based on book value.
In-depth comparisons are made regarding the hourly maintenance costs, downtime costs, and obsolescence costs that each affect total machine costs.
Overall, understanding these parameters is critical for making informed decisions about machine replacement and optimizing asset management.
Audio Book
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Understanding Economic Life
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So, basically that is what is this economic life. Economic life means it is a time during which the cost of holding the machine will be minimum. So, beyond the economic life you can see that there will be increasing costs associated with the machine, either due to increase in the operating cost that is repair and the maintenance costs or increase in downtime costs or increasing obsolescence cost.
Detailed Explanation
Economic life refers to the optimal period during which a machine can be operated at the lowest cost. After this period, costs related to repairs, maintenance, and obsolescence typically increase. Therefore, it's crucial to identify this period accurately to avoid financial losses associated with holding onto an outdated machine.
Examples & Analogies
Think of a car you own. When it is new, maintenance costs are low, and it runs efficiently. However, after several years, repairs become frequent and costly, leading the car to be a financial burden. Similarly, the 'economic life' of a machine indicates when transitioning to a newer model might be more beneficial than continuing to invest in the old one.
Estimating Economic Life with an Example
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In this example, we are going to see how to estimate the economic life of the machine. So, basically, so, here we are going to estimate economic life for a track mounted front shovel. The purchase price is 35,00,000. So, the machine is expected to last for 8 useful years and the depreciation is assumed to follow double declining balance method.
Detailed Explanation
In this example, the machine's purchase price is 3.5 million rupees, and it is expected to have an operational life of 8 years. The double declining balance method will be used to calculate depreciation, predicting how much value the machine loses over time.
Examples & Analogies
Imagine you buy a new smartphone for a considerable sum. As the years go by, its value decreases sharply due to wear and technological advancements. Similarly, the double declining balance method shows a more realistic depreciation value for machines, capturing rapid value loss at the start of their life.
Inflation Impact on Replacement Cost
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Due to inflation, you can see that annual increase of the average cost of the equipment is approximately 6%. That means, the machine cost is going to increase by 2,10,000 every year, due to the effect of inflation.
Detailed Explanation
Inflation affects the annual cost of machinery, making its replacement more expensive over time. In this case, an increase of 210,000 rupees per year reflects the rising costs in maintaining and eventually replacing the equipment.
Examples & Analogies
Consider how the prices of everyday goods, like groceries, tend to rise over time. If you plan to buy a loaf of bread now versus in a few years, you might find that its price has increased. The same principle applies to machinery costs due to inflation.
Calculating Depreciation Using Double Declining Balance
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We are going to estimate the depreciation using double declining balance method. D_n = (2/n) × BV_n-1. Say, for the first year, I have to estimate the depreciation now, D_1 = (2/8) × (35,00,000) = 8,75,000 rupees.
Detailed Explanation
The double declining balance method accelerates the depreciation in the early years of a machine's life. In this case, the first-year depreciation amounts to 875,000 rupees, which is computed using the formula where the machine's value is doubled and then divided by its total useful life.
Examples & Analogies
If you own a video game console, it might lose value quickly as new models are released. Similar to the double declining balance method, this depreciation captures the rapid drop in value for products that quickly become outdated, highlighting how you calculate depreciation for machines.
Understanding Cost Components in Replacement Analysis
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So, now let us work out the cost associated with the machine from the replacement analysis perspective. We have to consider all the components of the cost associated with the machine to have an accurate estimation of the optimum replacement time.
Detailed Explanation
To perform a thorough replacement analysis, several cost components must be analyzed, including depreciation, operational costs, maintenance, and potential downtime costs. This holistic approach ensures that decisions regarding machine replacement are data-driven and financially sound.
Examples & Analogies
Similar to budgeting for a household, when buying a new appliance, it’s essential to factor in not just the purchase price but also the costs of energy consumption and maintenance over its lifespan. Comprehensive analysis leads to more informed financial decisions.
Investment and Cumulative Costs
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Investment cost is given as 15% per year. Now, we are going to calculate the investment costs for the entire useful life of the machine. The cumulative usage now, every year the usage is 2000 hours.
Detailed Explanation
The investment cost, comprising the various charges associated with holding the machine (like interest and maintenance fees), is calculated as a percentage of the equipment's book value. Given the machine's usage of 2000 hours per year, this helps in understanding the overall accumulated costs as the machine ages.
Examples & Analogies
Imagine leasing an apartment where you not only pay rent but also maintenance fees and utilities; the total cost accumulates over time. Similarly, analyzing investment costs allows businesses to evaluate how well their machinery is performing against its expenses effectively.
Definitions & Key Concepts
Learn essential terms and foundational ideas that form the basis of the topic.
Key Concepts
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Economic Life: The time span during which holding a machine incurs minimal costs.
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Increasing Costs: As machines become older, costs rise due to factors such as repairs, extended downtime, and technological obsolescence.
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Replacement Analysis: To prevent losses, it's prudent to replace older machines with new ones as they surpass their economic life.
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Example Calculation:
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An example is provided involving a track-mounted front shovel with a purchase price of ₹35,00,000. The following details are pivotal:
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Depreciation Method: Double declining balance
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Useful Life: 8 years
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Salvage Value: ₹7,00,000
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Inflation Rate: 6% annual increase in equipment cost
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Investment Cost: 15% per year based on book value.
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In-depth comparisons are made regarding the hourly maintenance costs, downtime costs, and obsolescence costs that each affect total machine costs.
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Overall, understanding these parameters is critical for making informed decisions about machine replacement and optimizing asset management.
Examples & Real-Life Applications
See how the concepts apply in real-world scenarios to understand their practical implications.
Examples
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An example calculation of a track-mounted front shovel shows that after one year, its replacement cost increases due to depreciation and inflation.
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Through calculation, it can be demonstrated that waiting too long to replace machinery can lead to financial losses due to increasing operational costs.
Memory Aids
Use mnemonics, acronyms, or visual cues to help remember key information more easily.
🎵 Rhymes Time
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When machines age, costs can rise, keep track of life in wear and surprise.
📖 Fascinating Stories
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Imagine a farmer named Joe, who kept using an old mower. It worked well for years, but as time went on, repairs piled up and costs rose.
🧠 Other Memory Gems
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ECO-R - Economic life, Cost of delay, Oblsolescence, Replacement timing.
🎯 Super Acronyms
LAMP - **L**ifetime cost, **A**nalysis, **M**aintenance, **P**lanning.
Flash Cards
Review key concepts with flashcards.
Glossary of Terms
Review the Definitions for terms.
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Term: Economic Life
Definition:
The period during which a machine operates with minimal costs.
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Term: Replacement Analysis
Definition:
A systematic evaluation to determine the best time to replace a machine.
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Term: Depreciation
Definition:
The reduction in value of an asset over time.
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Term: Obsolescence
Definition:
Decline in value due to outmoded technology or features.
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Term: Downtime
Definition:
Periods when the machine is not operational, affecting productivity.