[Question] Project economics: as it relates to avoiding future costs.

I am currently working on the economics portion of a project to replace some equipment. A bit of a disagreement came up between my supervisor and myself on some details of the economics.

Some background: The equipment is in rough shape and could fail beyond repair in the next couple years, at which point it would need to be replaced. There is an increase in operational expense without the equipment. The project cost to replace by itself is about $600,000. However, operating without the equipment would be an additional $400,000 over the course of the six months we do not have working equipment. We could replace the equipment right now while we still have working equipment to avoid the $400,000 cost.

The disagreement comes in the cash flow analysis. When I do the cash flow, this is what I get (assuming that the equipment would fail in three years, as an example):

In other words, we should to spend $600,000 now to avoid a $1,000,000 cost in the future. However, my supervisor is saying that I cannot take the future cost of the equipment as a savings of doing the project now, as it is not an "avoided cost". In other words, my supervisor's cash flow would look something more like this:

So who is right here? I don't think it makes much sense that a total project cost of $1.0MM is better than a $0.6MM project cost now, even before discounting is applied! I could understand if it didn't make a necessary hurdle rate after discounting was applied... Maybe there is something that I'm not getting...

A few things to note:

• We are working with undiscounted cash at this point in the calculations.
• It is not guaranteed to fail in the third year. We can only take a reasonable guess as to when it will fail.