Replacement and Modernization

The main objective of modernization and replacement is to improve operating efficiency and reduce costs. Cost savings will reflect in the increased profits, but the rum’s revenue may remain unchanged. Assets become outdated and obsolete with technological changes. The firm must decide to replace those assets with new assets that operate more economically. If a cement company changes from semi-automatic drying equipment to fully automatic drying equipment, it is an example of modernization and replacement. Replacement decisions help to introduce more efficient and economical assets and therefore, are also called cost-reduction investments. However, replacement decisions, which involve substantial modernization and technological improvements, expand revenue as well as reduce costs.

Yet another useful way to classify capital investments is as follows:

• Mutually exclusive investments
• Independent investments
• Contingent investments.

Mutually exclusive investments serve the same purpose and  compete with each other If one investment is undertaken, others will have to be excluded. A company may, for example, either use a more labour-intensive, semi-automatic machine, or employ a more capital-intensive, highly automatic machine for production. Choosing the semi-automatic machine precludes the acceptance of the highly automatic machine. Independent investments serve different purposes and do not compete with each other

For example, a heavy engineering company may be considering expansion of its plant capacity to manufacture additional excavators and addition of new production facilities to manufacture a new product – light commercial vehicles. Depending on their profitability and availability of funds, the company can undertake both investments.

Contingent Investments are Dependent Projects

The choice of one investment necessitates that one or more other investments should also be undertaken. For example, if a company decides to build a factory in a remote, backward area, it may have to invest in houses, roads, hospitals, schools etc. for employees to attract the work force. Thus building of factory also requires investment in facilities for employees. The total expenditure will be treated as one single investment.

Contingent investments are dependent projects; the choice of one investment necessitates undertaking one or more other investment. For instance, if a company decides to build a factory in a remote, backward area, it may have to invest in houses, roads, hospitals, etc. For employers to attract the work force building of factory also requires investment in facilities for employees. The total expenditure will be treated as one single investment.