ELEMENTS WHICH REDUCE VALUE &7
identical plant, but at a cost dependent on new conditions, new
prices of labor and material, or it may mean the substitution
of new devices rendering equivalent service. In either event
the replacement may be at a greater or less cost than the original
cost, with, therefore, a corresponding increase or decrease of
capital invested. Expenditures for new parts of a plant, which
take the place of old parts which are retired for any cause, should
be charged to replacement only to the extent of capital repre-
sented by the part of the plant thus retired. Any excess of the
expenditure for replacement over the cost of the discarded part
of a plant should be treated as an addition to, and any less cost
as a deduction from, the invested capital. The term “ replace-
ment ” should not be used in the sense of retirement of invested
capital, which deals with the cost of the replaced part and not
with the cost of the new equivalent installation. Theoretically,
the amount which should go into an amortization fund should
be estimated on the basis of invested capital, or cost, and not
on the cost of replacement.
In the case of the supposed valuation by a seller and by a
purchaser of a plant with a 20-year useful life, at the end of a
10-year period, there is no need of assuming that an amortiza-
tion fund has actually been created. The amortization annuity,
instead of actually appearing in a fund, may be otherwise invested.
Example of Insufficient Amortization. — When the owner of a
steamboat which has a limited life and which is yielding 6 per cent
per annum of its cost and nothing for amortization, sets apart,
out of the 6 per cent, an annual amount, also bearing interest at
6 per cent, to meet its replacement at the end of the steamboat’s
life, he will have invested not only the original cost of the steam-
boat, no part of which comes back to him in the annual 6 per
cent return, but also a gradually increasing sum which in the
life of the steamboat will become adequate to replace it. At
the end of the steamboat’s usefulness, after replacing it with a
new one, the total original investment will be doubled without
any increase of earning capacity, and the owner will have, in
effect, lost his original investment.
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