Time Value of System Replacement Costs

In most retrofit applications, the new equipment being installed replaces existing equipment that is in working order. If the replaced equipment can be sold, it has salvage value, which is deducted from the initial investment. Similarly, if the new equipment will have a value after the term of the contract (or finance period), it also has salvage value. However, it is important to consider the consequences of maintaining that equipment in place and not making the investment in the new system. To do this in a life-cycle analysis, one must consider as the base case (or baseline) keeping the unit in place over its useful life. If the existing equipment requires an overall, the overhaul is considered the initial Year 0 investment in the base case.

In the life-cycle analysis, one must consider the year in which the existing equipment would have to be replaced. If, for example, the unit had a potential useful life of five years, the base case option would be to keep the unit in place and replace it in five years. The life-cycle analysis would compare the annual cash flows of the base case and the alternative case — installing the new equipment in Year 0. This life-cycle cost can then be compared with investing in the more efficient replacement equipment in Year 0 and operating that unit in each of the proceeding years. This type of analysis is only possible when one considers annual cash flows over the life cycle of an investment, put into financial perspective based on the time value of money.

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Guide to Alternative Fuels

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