23
REPLACEMENT ANALYSIS
CONTENTS
Replacement of Items that Deteriorate 207
Replacement of Items that Fail Suddenly 210
a) The Individual Replacement Policy 210
b) The Group Replacement Policy 211
Replacement analysis is the study of the planning, rationale and execution of the
effective replacement of an existing asset (i.e. components, parts, vehicles,
machinery) with a new asset(s). It involves determining the optimal time to
replace existing equipment with new ones, considering factors beyond mere
physical wear and tear. It distinguishes between the physical life and economic
life of an asset, where the latter dictates replacement based on factors like repair
costs and maintenance. The amount of time before an asset can no longer be used
or its value reaches zero is referred to as its physical life. The economic life
of an asset is the period of time when it is generating greater value than any
possible alternatives. A project’s economic life is always equal to or shorter than
its physical life.
Replacement decisions require choosing between the current asset, known as the
defender, and available alternatives, referred to as challengers. In various
sectors, equipment has a limited lifespan, and over time, they may fail suddenly
or wear out gradually, leading to decreased efficiency and affecting production
or benefits. As equipment ages or reaches the wearing-out stage, higher
operating and maintenance costs arise, prompting the consideration of complete
replacement. Examples include transportation vehicles, industrial machines,
and tires.
The various costs involved in replacement analysis are:
• The replacement cost of the item
• The consequential cost of failure
• The costs of the actual replacement
Replacement analysis aims to ensure efficient equipment functioning and
determine optimal replacement times to minimize overall maintenance costs.
Two primary replacement policies are:
i. Replacement of equipment/items that deteriorate or wear-out
gradually; and
ii. Replacement of equipment/items that fail suddenly.
REPLACEMENT OF ITEMS THAT DETERIORATE
The efficiency of equipment or items subject to gradual deterioration diminishes
over time, leading to progressive failure. This deterioration adversely affects
efficiency, resulting in (i) a decrease in production capacity, (ii) escalating
maintenance and operating costs, and (iii) a decline in the resale or salvage value
of the item. Considering these effects, it becomes both reasonable and
economical to replace deteriorating equipment or items with new ones. The
decision to replace is often based on repair and maintenance costs, and two
policies are considered:
a) Replacement of items that deteriorate but whose maintenance and repair
costs increase with time, ignoring changes in the time value of money.
208 Olaniyi Evans | University Mathematics
b) Replacement of items that deteriorate but whose maintenance and repair
costs increase with time, considering changes in the time value of money.
a) Replacement of Items that Deteriorate and Experience
Increasing Maintenance and Repair Costs
This involves minimizing the average annual cost of equipment when
maintenance costs increase over time, assuming a constant time value of money.
EXAMPLE 23.1
Historically, cost per year of operating an embroidery machine is as follows:
Year 1 2 3 4 5 6 7
Operating Cost ($) 570 590 1030 1310 1940 1990 2890
If the cost price is $12,000 and the scrap value is $2500, when should the
machine be replaced?
S O L U T I O N tips
Let C = cost of the equipment
S = scrap value of the equipment at the end of t years
𝐶 = 12,000 𝑆 = 2500
Year Running Cumulative Depression Total Cost Average
Cost ($) Running Cost Price ($) ($) Cost ($)
Cost ($)
𝑛
n X1 X3 = 𝐶 − 𝑆 X4 = X3 + X2 X5 = X4 /𝑛
X2 = ∑ X3
0
1 570 570 9500 10070 10070.00
2 590 1160 9500 10660 5330.00
3 1030 2190 9500 11690 3896.67
4 1310 3500 9500 13000 3250.00
5 1940 5440 9500 14940 2988.00
6 1990 7430 9500 16930 2821.67*
7 2890 10320 9500 19820 2831.43
The average cost is minimum in the sixth year. Thus, the machine should be
replaced at the end of the sixth year.
EXAMPLE 23.2
An owner of a printing machine, which costs $1000, estimates from past records
that the maintenance costs and resale values per year are as follows:
Year 1 2 3 4 5 6 7 8 9 10
Maintenance 60 80 100 120 130 370 420 440 450 490
Cost ($)
Resale Cost ($) 240 220 210 200 200 180 130 120 110 80
When should the machine be replaced?
S O L U T I O N tips
Year Resale PRS value ($) AM cost ($) CM cost ($) Total cost ($) Average
Value ($) cost ($)
𝑛
n X1 X 2 = 1000 − X1 X3 X5 = X2 + X4 X6
X4 = ∑ X3 = X 3/𝑛
0
1 240 760 60 60 820 820
2 220 780 80 140 920 460
3 210 790 100 240 1030 343.33
4 200 800 120 360 1160 290
5 200 800 130 490 1290 258*
6 180 820 370 860 1680 280
Chapter 23| Replacement Analysis 209
7 130 870 420 1280 2150 307.14
8 120 880 440 1720 2600 325
9 110 890 450 2170 3060 340
10 80 920 490 2660 3580 358
AM = Annual maintenance; CM = Cumulative maintenance; PRS = Purchase price resale
The average cost is minimum in the 5th year. Thus, the machine should be
replaced by the end of the 5th year.
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