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Replacement Policy

Published online by Cambridge University Press:  26 March 2020

R. R. Neild
R. R. Neild*
Affiliation:
National Institute of Economic and Social Research
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Extract

This note presents the results of a questionnaire enquiry into replacement policies used in a sample of firms, mainly in the engineering industry.

The enquiry was made as one part of a study of strategic factors in economic growth. This broader study has been focussed on the question : what factors influence the pace at which new and more efficient units of production, whether whole plants or individual machines, are introduced into industry in place of old ones, thus giving rise to increased productivity ?

Type
Articles
Information
National Institute Economic Review , Volume 30 , November 1964 , pp. 30 - 43
Copyright
Copyright © 1964 National Institute of Economic and Social Research

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Footnotes

This article was prepared by R. R. Neild, of the National Institute of Economic and Social Research. Since the article was written, Mr. Neild has accepted a post in H.M. Treasury.

References

Note (1) page 31 The diagram represents machines actually installed; the slope depends not simply on the rate of technical progress (which reflects the historical pace of invention and develop ment) but also the rate at which the available better techniques are selected.

Note (1) page 32 Since the timing of replacement of to-day's machine influences all subsequent decisions to replace its successors, the right choice depends, strictly speaking, on minimising the present cost of the infinite series of replacements that will occur if the present asset is to be repeatedly replaced; and any replacement formula must depend on the assumption that subsequent replacements are made optimally.

Note (1) page 33 Alternatively a net present value can be computed. This is another way of indicating how far the returns exceed a given minimum.

Note (2) page 33 See G. Terborgh, Dynamic Equipment Policy, McGraw- Hill 1949, and, for the revised and improved method, G. Terborgh, Business Investment Policy, Machinery and Allied Products Institute, 1200 Eighteenth Street, Northwest, Washington 6, D.C. (1958).

Note (1) page 34 The peculiarity of the MAPI system is that it uses a fixed figure (just over 8 per cent) for discounting future earnings and then, via the resulting capital consumption allowance, arrives at a first year return which may differ from the rate used for discounting. This means that the resultant figure is not directly comparable with a discounted cash flow rate of return (or a net present value); but the ranking of projects will generally be the same and so will the cut-off point at the minimum rate of return used for dis counting.

Note (2) page 34 If capital outlay on the old machine would be significant in the absence of replacement—for example, if major recon ditioning were required—replacement means that recovery of this outlay over the expected extra life of the old machine is avoided. A figure representing this avoided annual capital charge should therefore be added to the operating advantage of the new machine.

Note (3) page 34 See G. H. Lawson, Criteria to be Observed in Judging a Capital Project’, The Accountants Journal, May and June 1964.

Note (4) page 34 A. J. Merrett and Allen Sykes, The Finance and Analysis of Capital Projects, Longmans, 1963. A. M. Alfred, ‘Discounted Cash Flow : The Proper Assessment of Invest ment Projects,’ The Investment Analyst, No. 7, December 1963. Tibor Barna, Investment and Growth Policies in British Industrial Firms, Cambridge University Press, 1962.

Note (1) page 35 Recent Economic Changes in the United States. Report of the Committee on Recent Economic Changes, of the President's Conference on Unemployment, including the reports of a special staff of the National Bureau of Economic Research, Inc. Vol. 1, McGraw-Hill, New York, 1929.

Note (2) page 35 Joel Dean, Capital Budgeting : Top Management Policy on Plant, Equipment and Product Development, Columbia University Press, New York, 1951.

Note (3) page 35 See, for example, enquiries referred to in Terborgh, Dynamic Equipment Policy, op. cit.; McGraw-Hill survey of ‘Business Needs for New Plant and Equipment, 1949-53’, January 1949; and Norman E. Pflomm, Managing Capital Expenditures, Study No. 107, National Industrial Conference Board, New York, 1963.

Note (4) page 35 See, for example, Vernon L. Smith, Investment and Production : A Study in the Theory of Capital-using Enter prise, Harvard University Press, 1961, which includes a bibliography of relevant theoretical work.

Note (5) page 35 See Graham Hutton, We Too Can Prosper, Allen & Unwin, 1953, p. 85.

Note (1) page 36 Report of the Committee on Turnover Tax, Cmnd. 2300, March 1964, paragraph 282.

Note (2) page 36 See FBI evidence to the Committee on the Working of the Monetary System, op. cit. page 9; H. Hart and D. F. Prusmann, ‘A Report of a Survey of Management Accounting Techniques in the S.E. Hants Coastal Region.’ (Mimeo) Department of Commerce and Accountancy, University of Southampton, December 1963; D. C. Corner and Alan Williams, ‘The Sensitivity of Businesses to Initial and Invest ment Allowances’, Feb. 1964 (mimeo), to be published in Economica. The last paper summarises the results of the others.

Note (3) page 36 The investment allowance of 30 per cent, the typical rate for machine tools, amounts to a subsidy of 30 multiplied by 53.75 per cent (income tax at 38.75 plus profits tax at 15 per cent) = 16 per cent approximately. This is obtained after the delay between the purchase of the machine and the settlement of the first year tax.

Note (1) page 37 Differences in coverage do not appear to be important. The 1948 figures are available for ten United States industrial groups embracing most of manufacturing. They are generally lower than the 1928 figure for all manufacturing.

Note (1) page 38 See Metalworking Production, December 1961, McGraw- Hill, London.

Note (2) page 38 Plant and machinery is divided into five groups for which the estimated lives are 16, 19, 25, 34 and 50 years. See National Income and Expenditure, 1964, H.M.S.O., page 106.

Note (3) page 38 For the sake of simplicity, no salvage value has been allowed for. This, however, will not greatly affect the calculations.

Note (1) page 38 Since many establishments were represented at the con ference by more than one person this figure is considerably smaller than the number of participants.

Note (2) page 38 See Committee on the Working of the Monetary System, Principal Memoranda of Evidence, Vol. 2, pp. 118/119, H.M.S.O., 1960.

Note (3) page 38 See G. H. Lawson, Criteria to be Observed in Judging a Capital Project’, The Accountants Journal, May and June 1964, op. cit., D. C. Corner and Alan Williams, The Sensitivity of Businesses to Initial and Investment Allowances ‘(mimeo) Exeter University, February, 1964, and Tibor Barna, Investment and Growth Policies in British Industrial Firms, Cambridge University Press, 1962, op. cit.

Note (1) page 39 See J. H. Dunning, American Investment in British Manufacturing Industry, Allen and Unwin, 1958, p. 12.

Note (2) page 39 In comparing our figures with those from the Census, it should be noted that ours are narrower in coverage. They refer to operatives only, whereas the Census refers to the total number employed.

Note (1) page 40 One firm, which answered rate of return, added that for large projects it was increasingly using discounted cash flow plus pay-off period.

Note (2) page 40 In addition, two firms, now using a pay-off period, said they were introducing MAPI.

Note (3) page 40 This was not asked explicitly in the questionnaire.

Note (1) page 41 It is sometimes suggested that, in replying to question naires, people if uncertain what to say, may tick the first suggested answer in preference to others. It is perhaps encouraging that in these two enquiries the pay-off period was listed first in one questionnaire and second in the other, yet the answers were much the same.

Note (2) page 41 For an analysis of the possible rates of return implied by pay-off periods of 3 and 5 years, see page 38

Note (3) page 41 Both these replies with exceptionally long pay-off periods were queried, but found to be valid.

Note (1) page 42 Includes two instances of amount related to past replace ment budget; one based on a relationship to the present value of plant; one based on relationship to the replacement value and life of plant.

Note (2) page 42 Includes three groups where large expenditures were authorised at the centre and smaller ones were delegated.

Note (1) page 43 Two statistical tests were applied in order to examine more precisely the relationship between size of firm and the answers given. It was apparent from inspection that for only five of the questions was any such relationship likely to be found. These were the questions relating to:

  • (a) main consideration governing decision to replace,

  • (b) the use of written estimates,

  • (c) the criterion adopted,

  • (d) treatment of tax,

  • (e) whether an agreed amount is put aside for replacement.

In each case the responses to the questions were treated as a simple alternative in respect of the most sophisticated practice-for example, whether the main consideration was cost saving or not.

The first test was of the contingency tables formed by grouping firms according to response and three size classes : small (less than 250 operatives), medium (251 to 1,000 operatives, and large (more than 1,000 operatives). In only one case, the use of written estimates, was the value of χ2 such as to reject the null hypothesis of independence between size and form of response at even the 10 per cent level of significance. Even taking all five questions together no significant relationship was found.

A second and possibly more powerful test was made by comparing the mean sizes of the firms in the two alternative groups of respondents for each question. On this test significant differences in size were found in regard to the use of written estimates and the criterion adopted, in both cases at the 5 per cent level of significance.

It may be noted that in making the tests four giant com panies were excluded—those organisations whose branches are already included separately. Their influence on the results of the second test especially would have been quite excessive.

A correction has been issued for this article:

Errata