Economic consistency of salvage value definitions

Résumé 0

This short report analyzes the definition of the salvage value of a component within a wider project investment analysis. The analysis shows that the classical(*) definition is close but not exactly consistent from an economic point of view. For an exact economic consistency of the salvage value, we derive an alternate definition using a more complex formula, which we call the economically consistent salvage value. This formula is equivalent to the classical definition when the discount factor is zero. The key takeaway of our analysis is that using the classical definition creates an overestimation of the annualized project cost of up to 30% in the worst cases (see section 3), even for a small discount factor!(*) classical definition in the field on energy system optimization at leastOne year after the 2023 version of this report, we found references from the Engineering Economics literature showing that the formula we derived was in fact already known under the term “implied” (Thuesen 1984) or “imputed” (Jones 1990) salvage value. Notice that we didn't rewrite the entire document to reflect the preexistence of these references, but comparisons are done in Appendix 6.2 to verify the equivalence between ours and literature definitions.Still, all the analyses (graphics, series development and sensitivity to interest rate and lifetime), presented in this document are, to the best of our knowledge, original. Another contribution is the generalization in the case of component replacements (section 4.1).