Information Requirements of Replacement Models

Abstract

The methods used in determining when to replace equipment can be classified under five headings: 1. Replacement on the basis of book value. Some companies replace equipment only when fully depreciated-often using lives prescribed by tax authorities. This approach may yield optimum replacement, but if it does, the happy result seems purely accidental. It is unlikely that an asset will collapse the instant it is recorded as fully depreciated. 2. Replacement on the basis of subjective judgment. In lieu of the deterministic first method, some companies replace on the basis of subjective judgment A gas and electric company studied by the writer replaces its motor vehicles when the shop foreman considers that they are due for their first major overhaul. This approach is attractive since decisions are based on the experience of men presumed to know the equipment best; but, as with the preceding method, there is never an evaluation of the relative, profitability of alternative replacement decisions. 3. Replacement on the basis of arbitrary payoff. Various rules-of-thumb have been devised to supplement intuitive judgment. One popular rule signals replacement when the payoff from a -new unit (capital outlay/