Why do I need to upgrade my hardware now, you may ask, if it has worked well all these years? This is a classic capital investment question and it is very easy to get confused by outlay costs, operating costs and tax consequences when making such a decision.
At the risk of diving into finance, the traditional approach is to compare cash flows of the status quo versus the hardware refresh scenario. Let's take the example of a four server environment versus consolidating down to one virtualized server. According to Corporate Finance, there is a fairly straight forward way to make this decision.
- Calculate the Equivalent Annual Cost (EAC) for the new equipment
- Calculate the yearly cost for the old equipment
- "Replacement should occur right before the cost of the old equipment exceeds the EAC on the new equipment"
So, to use a server virtualization example, assume that the project costs $27K and requires maintenance of $1K at the end of every year for 5 years. The existing equipment requires $3K of maintenance for the following year.
I am going to oversimplify the math, but here are the pieces:
Costs in today's dollars = $27K + maintenance cost - salvage cost = $27K
To calculate EAC, we look at what this would be over 5 years which is roughly $8K (future dollars are worth less than current).
We demonstrated some of the additional costs of a standard server deployment in Will Virtualization Cost More Than A Standard Network Installation?
The cost of keeping the old equipment one more year is:
- Opportunity cost of not selling ($4,000)
- Additional maintenance ($3,000)
- Additional power and cooling ($6,000)
- Salvage value (-$2,500)
Again, we have to put this in todays dollar's or roughly $10K. Since we are deciding whether to keep the whole thing for an extra year, we project out the future value to $11K.
So, in this example, it is worth doing the virtualization project right away to minimize costs in year 1. We did not include tax implications which would have strengthened the investment case.
How do you decide when to upgrade your hardware?
- Identify all of the cost elements of maintaining old hardware, including opportunity costs
- Remember to account for the time value of money
- Replace old hardware as soon as the cost of the old equipment exceeds the Equivalent Annual Cost of the new equipment
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