Replacement Problems

Introduction:
The efficiency of all industrial and military
equipments deteriorates with time. Sometimes the
equipment fails completely and effects the whole
system. The maintenance costs (running costs) of an
equipment also go on increasing with time. Thus it
becomes more economical to replace the old
equipment with a new one. Hence there is a need to
formulae a most economical replacement policy
which is in the best interest of the system.
 There are following types of Replacement problems under
discussion:
1. Replacement of major or capital item (equipment) that
deteriorates with time; e.g., Machines, Trucks etc.

2. Replacement of an item (equipment) in anticipation of complete

failure, the probability of which increases with time (or age).

3. Problems in morality and staffing.

4. Replacement of an equipment (or item) may be necessary due to

new researches, otherwise the system may become out of date.
Replacement of major or capital item
(equipment) that deteriorates with time; e.g.,
Machines, Trucks etc.

For machine the maintenance cost always increase with time and stage
comes when the maintenance cost becomes so large that it is
economical to replace the machine with a new one. Thus the
problem of replacement in this case is to find the best time (age of
machine) at which the old machine should be replaced by the new
one.
To Find The Best Replacement Age (Time) of a
Machine When
(1) Its maintenance cost is given by a function increasing
with time.
(2) Its scrap value is constant and,

(3) The Money value is not considered.

Let C = Cost of Machine
S = Scrap value of the machine at time t.
and, Cm(t) = Maintenance cost of machine at time t, [Cm(t) increases with t].

Case 1 : When time ‘t’ is a continuous variable.

n
Total maintenance cost of the machine in n years  C m ( t ) dt
0

The total cost of machine in n years

= Cost of machine – Scrap value of machine + Total maintenance cost in n years.
 n
 C  S   C m ( t )dt
0

The average cost of maintenance per year during n years is given by

n
C  S   Cm (t )dt
0
A(n) 
n
n
CS 1
A(n)    Cm (t )dt.......................(1)
n n0
Now for A (n) to be minimum,
n
d
 A(n)    C 2 S  12  Cm (t )dt  1 Cm (t )
dn n n 0 n
n
C  S   Cm (t )dt
 Cm (t )  0
 A(n) [ from (1) ]
n
i.e. Maintenance cost of the machine at time t
= Average cost of the machine per year.

n
Also d 2 A( n ) 2 (C  S ) 2
  C m ( t ) dt  0
dn 2 n3 n3 0

Hence, the average cost of the machine per year is

minimized by replacing it when the average cost to date
becomes equal to the current maintenance cost.
Case 2 : When time ‘t’ is a discrete variable.
When time t takes the values 1, 2, 3,…..etc., then the total maintenance cost of the
machine in n years
n
  Cm (t )
m 1

Therefore, in this case the average cost of the machine per year during n years is
given by
n
C  S   Cm (t )
CS 1 n
A(n)  m 1
   Cm (t ).........(2)
n n n m 1

But A(n) is minimum for that value of n for which

 (An -1) < 0 <  A (n)…………………….(3)
 A(n) = A(n + 1) – A(n)

C  S 1 n 1  C  S 1 n 
  
 n  1 n  1 m 1
Cm (t )  
  n
  Cm (t )
n m 1 
  1 1   1  n  1 n
 C  S      Cm (t )  Cm1 (t )   Cm (t )
 n  1 n   n  1   m 1  n m 1
(C  S )  1 1 n 1
    Cm (t )  Cm 1 (t )
n(n  1)  n  1 n  m 1 n 1
n
 
 (C  S )  
m 1
C m (t )  1
   Cn 1 (t )
 n( n  1)  n 1
 
A(n) 1
  Cn 1 (t ) from...( 2)
n 1 n 1
A( n  1) 1
A( n  1)    Cn (t )
n n
From (2) A(n) is minimum for value of n for which
A(n) > 0 and A(n -1) < 0
 A (n ) 1
i.e.,   C n 1 (t )  0
n 1 n 1
and A ( n  1) 1
  C n (t )  0
n n
or C n 1 (t )  A ( n )
and C n ( t )  A ( n  1)

From (4), we conclude that

1. Do not replace if the next years maintenance cost is less than the previous years
average total cost.
2. Replace if the next years maintenance cost is greater than the previous years
average total cost.

A Machine is continued up to the time the average cost per year (including cost of
the new machine, maintenance cost etc.) of the machine decrease and is
replaced at the time when its cost begins to increase.
Case 1:

The cost of a bike is $ 3000. The salvage value (resale value) and the running cost
are given as under. Find the most economical replacement age of the truck.

Table 1

Year 1 2 3 4 5 6 7
Running Cost 600 700 800 900 1000 1200 1500
Resale value 2000 1333 1000 750 500 300 300
Solution:

Table 2

Age of Replacement Total Depreciation = Total Cost Average Cost per

(in Years) Running Cost Cost of bike – Resale ($) year
($) Value ($)
($)
1 600 1000 1600 1600.00
2 1300 1667 2967 1483.50
3 2100 2000 4100 1366.66
4 3000 2250 5250 1312.50
5* 4000 2500 6500 1300.00*
6 5200 2700 7900 1316.67

Replace the bike in 5th year.

Case 2:

Machines in a factory have increased cost as they continue in service due to

increased running cost. The initial running cost is Rs 3,500 and resale price drops as
time passes until it reaches a constant value of Rs 500. Determine the proper length
of service before machines should be replaced. Cost data are given below.

Table 3

Year of Service 1 2 3 4 5
Running Cost 1800 2200 2700 3200 3700
Resale value 1900 1050 600 500 500
Solution:

Year Running Cumulative Resale Difference Average Average Average

of Cost Running Price between Investment Running Cost
Service Cost Initial Cost cost per Cost per Per Year
and Year Year
Resale
Price
1 2 3 4 5 6 = 5/1 7 = 3/1 8=6+7
1 1800 1800 1900 1600 1600 1800 3400
2 2200 4000 1050 2450 1225 2000 3225
3 2700 6700 600 2900 967 2233 3200
4 3200 9900 500 3000 750 2475 3225
5 3700 13600 500 3000 600 2720 3320

Replace the machine in 4th year.

Case 3:

A. Machine A costs Rs 9000. Annual operating cost are Rs 200 for the 1st
year, and then increase by Rs 2000 every year. Determine the best age at which to
replace the machine. If the optimum replacement policy is followed, what will be
the average yearly cost of owing and operating the machine ? (Assume that the
machine has no resale value when replaced, and that future cost are not
discounted).

B. Machine B costs Rs 10,000. Annual operating costs are Rs 400 for the first
year, and then increase by Rs 800 every year. You have now a machine of type A
which is one year old. Should you replace it with B, and if so when ?

C. Suppose you are, just ready to replace machine A with another machine of
the same type, when you hear that machine B will become available in a year. What
you should do ?
Solution:
a. The maintenance cost of machine A per year are as follows:

Table 3
Year 1 2 3 4 5
Maintenance cost in Rs 200 2200 4200 6200 8200

To find the average cost per year of machine A, we prepare the following table:
Table 4
Replacement at the end Total Running Cost Depreciation Total Cost Average Cost
of the year Rs Rs Rs Rs
1 200 9000 9200 9200
2 2400 9000 11400 5700
3* 6600 9000 15600 5200
4 12,800 9000 21,800 5450

It is clear from the table that the machine A should be replaced at the end of the 3rd
year. The average yearly cost in this situation will be Rs 5200.
b. The maintenance cost of machine B per year are as follows:

Table 5
Year 1 2 3 4 5 6 7
Maintenance cost in Rs 400 1200 2000 2800 3600 4400 5200

To find the average cost per year of machine A, we prepare the following table:
Table 6
Replacement at the end Total Running Cost Depreciation Total Cost Average Cost
of the year Rs Rs Rs Rs
1 400 10000 10400 10400.00
2 1600 10000 11600 5800.00
3 3600 10000 13600 4533.33
4 6400 10000 16400 4100.00
5* 10000 10000 20000 4000.00
6 14400 10000 24400 4066.66
It is clear from the above table that if machine B is replaced after 5 years then its average cost
per year is Rs 4000.
Since the lowest average cost Rs 4000 for machine B is less than the lowest average cost Rs
5200 for machine A, the machine A should be replaced by machine B.
To find the time of replacement of machine A by machine B.
The machine A is replaced by machine B at the time (age) when its running cost of the next
year exceeds the lowest average yearly cost Rs 4000 of machine B.

Total cost of machine A in the successive years are as follows:

Table 7
Year 1 2 3 4 5
Total cost in the year 9200 Rs 11400 – Rs 15600 Rs 21800 Rs 30000
9200 = Rs 2200 – 11400 = – 15600 = – 21800 =
Rs 4200 Rs 6200 Rs 8200

The running cost of third year of machine A is Rs 4200 which is more than the lowest
average yearly cost Rs 4000 of machine B. Therefore, the machine A should be replaced by
machine B when its age is 2 years. Since the machine A is one year old now, therefore it
should be replaced after one year from now.
c. As shown in (b), the machine A should be replaced after one year from
now and the machine B also available at that time. Therefore, the machine A
should be replaced by machine B after one year from now.

Case 3:
For a machine, from the following data are available:
Table 8
Year 0 1 2 3 4 5 6
Cost of spares (Rs) - 200 400 700 1000 1400 1600
Salary Maintenance staff (Rs) - 1200 1200 1400 1600 2000 2600
Losses due to break down (Rs) - 600 800 700 1000 1200 1600
Resale value 12000 6000 3000 1500 800 400 400

Determine the optimum period for replacement of the above machine.

Few Important Terms:

Money Value:

The time value of money is the value of money figuring in a given amount of
interest earned over a given amount of time.

The value of money changes with time. The statement is explained by the following
example.
If we borrow Rs 100 at interest of 10% per year then after one year after one year
we have to return Rs 110. Thus Rs 110 after one year from now are equivalent to Rs
100 today. Therefore, Rs 1.00 after one year from now is equivalent to Rs 100/110
i.e., (1.1)-1 today at the rate of 10% So, Rs 1.00, n year from now is equivalent to Rs
(1.1)-n today at the rate of 10% thus we can say that the value of money changes with
time.
Present Value or Present Worth:

We have shown that Rs 100, n years after from now is equivalent to Rs (1.1)-n today
at the rate of 10%. In other words we say that (1.1)-n is the present value (or present
worth) of one rupee spent after one year from now.
In general if the interest on Rs 1 is Rs ‘i’ per year, then the present value of Rs 1 to
be spent after n years from now is Rs 1 (1  i ) n
Discount Rate or Depreciation Ratio:
The value of the money decreases with a constant ratio which is known as its
discount rate or depreciation ratio.
If r is the ratio of interest per year on Rs 1.00. Then the present value of Rs 1.00 to
be spent after one year from now is Rs 1 (1  r ).
1
The ratio v  is the discount rate or depreciation ratio which is less than one.
(1  r )
To determine the best replacement age of items whose
maintenance cost increase with time and the value of
Money also changes with time:

1  v n 1 1  v n 1
.C n  P ( n  1)  0  .C n  1  P ( n )
1 v 1 v

Thus, the best replacement age of machine is n years for which the above inequality
holds.

1. Do not replace if the operating cost of next period (year) is less than the
weighted average of previous cost.
2. Replace if the operating cost of the next period (year) is greater than the
weighted average of the previous cost.
Case: The cost pattern for two machines A and B when money value is not
considered, is given as follows:

Table 9
Year
Machine A Machine B
1 900 1400
2 600 100
3 700 700
Total 2200 2200

Find the cost for each machine, when money is worth 10% per year, and hence find
which machine is less costly.
Solution :
The total expenditure for each machine in 3 years is equal to Rs 2200 when the
money value is not taken in to consideration. Thus, the two machines are equally
good if the money has no value over time.
When money value is 10% per year the discount rate
100
v  0.9091
100  10

The present value of the maintenance cost in years 1, 2, 3 for two machines are
shown in following table
Table 10
Year
Machine A Machine B
(Rs) (Rs)
1 900 1400
2 600 × (0.9091) = 545.45 100 × (0.9091) = 90.91
3 700 × (0.9091)2 = 578.52 700 × (0.9091)2 = 578.52
Total Rs 2023.97 Rs 2069.43

The present value of the total expenditure for machine A in three years is less than
that of machine B. hence machine A is less costly.
Case :
Let the value of money be assumed to be 10% per year and suppose that the
machine A is replaced after every 3 years whereas machine B is replaced after every
six years. The yearly costs of both the machines are given as under.
Table 11
Year 1 2 3 4 5 6
Machine A : 1000 200 400 1000 200 400
Machine B : 1700 100 200 300 400 500

Determine which machine should be purchased.

Solution :
100 10
Since the value of money is 10% per year, the discount rate v 
100  10 11

 The total discount cost (present worth) of costs of machine A for 3 years is
2
 10   10 
 1000  200     400     Rs 1512 app
 11   11 
and the total discount cost (present worth) of costs of machine B for 6 years is
2 3 4 5
 10   10   10   10   10 
 1700  100     200     300     400     500     Rs 2765 app
 11   11   11   11   11 

 The average yearly cost of Machine A = 1512/3 = Rs 504

And average yearly cost of machine B = 2765/6 = Rs 460.83

From here machine B looks less costly but its not true because the time periods
considered are not the same

Now the total discount cost of costs of machine A for 6 years

= 1000 + 200 × (10/11) + 400 × (10/11)2 + 1000 × (10/11)3 + 200 × (10/11)4 + 400 ×
(10/11)5 = Rs 2647 app

The present value of the total expenditure in 6 years on machine A is less than that
for machine B. Thus the machine A is less costly and hence machine A should be
purchased.
A pipeline is due for repairs. It will cost ` 10,000 and lasts for
three years. Alternatively, a new pipeline can be laid at a cost of `
30,000 and lasts for 10 years . Assuming cost of capital to be 10%
and ignoring salvage value, which alternative should be chosen.

Consider two types of pipelines for infinite replacement cycles of 10 years for the
new pipeline, and 3 years for existing pipeline.

100
The present worth factor is given by; v   0 .09091
100  10

Let Dn denote the discounted value of all future costs associated with a policy of
replacing the equipment after n years. Then if we designate the initial outlay by C,
     
Dn  C  vnC  v2nC  ...  C 1  vn  v2n  ...  C 1  vn  C / 1  vn 
C
Dn 

1  vn 
10,000
D3   Rs40021

1  0.9091
3

and,
30,000
D10   Rs48820

1  0.9091
10

D3  D10

The existing pipeline should be continued.

Case 4:
A manufacturer offered two machines A and B. A is priced at Rs 5000 and running
cost are estimated at Rs 800 for each of the first 5 years, increasing by Rs 200 per
year in the 6th and subsequent years. Machine B, which has the same capacity as A,
costs Rs 2500 but with running cost of Rs 1200 per year for the first six years,
increasing by Rs 200 per year there after. If money is worth 10% per year, which
machine should be purchased?
(Assume that the machine will eventually be sold for scrap at negligible price.)

Solution:
If n is the optimum replacement age of the machine we have

1  v n 1 1  v n 1
.C n  P ( n  1)  0  .C n  1  P ( n )......... .. 1
1 v 1 v

Where, P (n) = A + C1 + C2v + C3v2 +……+Cnvn-1

Here, v = 0.9091, 1 – v = 1/11.

For machine A, A = Rs 5000
To find the value of n, satisfying (1) for machine A, we compute this table.
 Table 12
Year Cn vn-1=(0.909)n-1 (vn-1) Cn (1-vn-1) Cn (1  v n ) P(n) (1 vn )
C n 1 Cn1  P(n)
n 1 v 1 v
1 2 3 4=2×3 5=2–4 6 7 8=6–7
1 800 1.0000 800 0 800 5800 <0
2 800 0.9091 727 73 1529 6527 <0
3 800 0.8264 661 139 2189 7188 <0
4 800 0.7513 601 199 2794 7789 <0
5 800 0.6830 546 254 4169 8335 <0
6 1000 0.6209 621 379 5753 8956 <0
7 1200 0.5645 677 523 7502 9633 <0
8 1400 0.5132 718 682 9394 10351 <0
9* 1600 0.4665 746 854 11407 11097 >0
10 1800 0.4241 763 1037 - -

Form the table, it is clear that equation (1) satisfied for n = 9.

It would be best to replace machine A after 9 years. The fixed annual payment for
machine A
1 v
x1  .P (9 )
1 v9
1  0 . 9091 0 . 0909
  11097   11097
1  ( 0 . 9091 ) 9 1  0 . 4241
 Rs 1752
Again for machine B, A = Rs 2500
To find the value of n satisfying (1) for machine B, we compute thee following table

Table 13
Year Cn vn-1=(0.909)n-1 (vn-1) Cn (1-vn-1) Cn (1  v n ) P(n) (1 vn )
C n 1 Cn1  P(n)
n 1 v 1 v
1 2 3 4=2×3 5=2–4 6 7 8=6–7
1 1200 1.0000 1200 0 1200 3700 <0
2 1200 0.9091 1091 109 2288 4791 <0
3 1200 0.8264 992 208 3278 5783 <0
4 1200 0.7513 902 298 4180 6685 <0
5 1200 0.6830 820 380 5005 7505 <0
6 1200 0.6209 745 455 6710 8250 <0
7 1400 0.5645 790 610 8369 9040 <0
8* 1600 0.5132 821 779 10560 9861 >0
9 1800 0.4665 840 960 - -

Form the table, it is clear that equation (1) satisfied for n = 8.

It would be best to replace machine B after 8 years. The fixed annual payment for
machine A
 1 v
x2  .P (8 )
1 v8
 Rs 1680

Since x1 > x2
It would be better to purchase machine B instead of A.
Replacement of the machines in anticipation of complete
failure the probability of which increases with time:
In general the probability of failure of an item increases with time. The complete
failure of an item (machine) may result in complete break down of the system which
puts the organization to a heavy loss. Thus there is a need of some replacement
policy of such items to avoid the possibility of complete breakdown. Such items may
be replaced even when they are in working order.
The following policies are followed:

1. Individual Replacement Policy:

According to this policy the failed item is immediately replaced by the new one, e.g.
in house fused bulb is replaced by the new one.
1. Group Replacement Policy:

In general a system contains a large number of identical low – cost items such that the
probability of their failure increases with time or age. In such cases there is a set up
cost for replacement which is independent of the number replaced. Here in such
systems it may be advantageous to replace all the items at some fixed interval. Such
policy is called the group replacement policy. This policy is followed in the systems
where the cost of an individual item is so small that the cost of keeping records of
individual’s age can not be justified.
To determine the interval of optimum replacement:
Group replacement should be made at the end of nth period if the cost of individual
replacement for the n – th period is greater than the average cost per period by the
end of n periods.
Group replacement should not be made at the end of nth period if the cost of individual
replacement at he end of (n - 1)th period is not less than the average cost per period
by the end of (n - 1) periods.
Problems in Morality:

The problems are the special cases of the problems in industry where the failure of any
item (machine) can be treated as death and the replacement of any item (machine)
can failure can be taken to a birth in the human populations. We consider the
following morality problem:
Let a large population be subjected to a given morality curve for a very long period of
time under the following assumptions.
(i) All death's are immediately replaced by births.
(ii) There are no other entries or exit.

Then we shall prove the following results

(i) The number of deaths per unit time becomes stable.

(ii) The age distribution ultimately becomes stable.
Staffing Problem:

The problems connected with recruitment and promotion of the staff in any system
(organization)are known as the staffing problems. These problems are also treated
as the replacement problem where the staff of the system is treated like a machine
part. The problem of staff replacement arises due to resignation, retirements deaths
of the staff members from time to time. Therefore to maintain a suitable strength of
the staff in a system there is a need of some useful recruitment policy.
Morality Tables:
Morality tables for any item can be used to obtain the probability distribution of its life
span.
Let N = The total number of items in the system in the beginning
And N (t) = Number of survivors at any time t.
Then the probability that any item will fail in the time interval (t – 1, t) is given by
N ( t  1)  N ( t )
.......... .........( 1 ) since N (t - 1) > N (t)
N

And the probability that any item that survived up to the age (t - 1) will die in the next
year is given by
N ( t  1)  N ( t )
.......... .........( 2)
N ( t  1)
Case:
The following morality rates have been observed for a certain type of light bulb:

Week 1 2 3 4 5
Percent failing by the end of the week 10 25 50 80 100

There are 1000 bulbs in use and it costs Rs 1.00 to replace an individual bulb which has
burnt out. If all bulbs were replaced simultaneously it would cost 25 paise per bulb.
It is proposed to replace all bulbs at fixed intervals, whether or not they have burnt
out and to continue replacing burnt out bulbs as they fail. At what intervals should
all the bulbs be replaced?
Solution:
If P1 is the probability of failure of a new bulb in ith week, then

10
P1   0.10 80  50
100 P4   0.30
100
25  10
P2   0.15 100  80
100 P5   0.20
100
50  25
P3   0.25 Here , P1  P2  P3  P4  P5  1
100
Since the sum of all probabilities is equal to 1.
 P6, P7, ……. Are all zero.
Therefore, a bulb can not survive for more than five weeks i.e., a bulb which has survived
for four weeks is sure to fail in the fifth week.
Assuming that the burnt out bulbs in any week are replaced just at the end of that work. If
Ni be the number of replacements at the end of ith week, while all 1000 bulbs were
new initially, then we have
N0 = Number of bulbs in the beginning. = 1000
N1 = Number of burnt out bulbs replaced at the end of 1st week
= N0P1 = 1000 × 0.10 = 100
N2 = Number of burnt out bulbs replaced at the end of 2nd week
= N0P2 + N1P1 = 1000 × 0.15 + 100 × 0.10 = 160
N3 = Number of burnt out bulbs replaced at the end of 3rd week
= N0P3 + N1P2 + N2P1 = 1000 × 0.25 + 100 × 0.15 + 160 × 0.10 = 281
N4 = Number of burnt out bulbs replaced at the end of 4th week
= N0P4 + N1P3 + N2P2 + N3P1
= 1000 × 0.30 + 100 × 0.25 + 160 × 0.15 + 281 × 0.10 = 377
N5 = Number of burnt out bulbs replaced at the end of 5th week
= N0P5 + N1P4 + N2P3 + N3P2 + N4P1
= 1000 × 0.20 + 100 × 0.30 + 160 × 0.25 + 281 × 0.15 + 377 × 0.10 = 350
N6 = Number of burnt out bulbs replaced at the end of 6th week
= N0P6 + N1P5 + N2P4 + N3P3 + N4P2 + N5P1
= 0 +100 × 0.20 + 160 × 0.15 + 281 × 0.25 + 377 × 0.15 + 350 × 0.10 = 230
N7 = Number of burnt out bulbs replaced at the end of 7th week
= N0P7 + N1P6 + N2P5 + N3P4 + N4P3 + N5P2 + N6P1
= 0 + 0 + 160 × 0.20 + 281 × 0.30 + 377 × 0.25 + 350 × 0.15 + 350 × 0.10 + 230 × 0.10
= 230
And so on……..

From the above calculations we see that Ni the expected number of bulbs failing each week
increases up - to fourth week and then decreases up to 6th week and then increases
again. In this way Ni oscillates till the system settles down to steady state.
The average life of bulb
=  Xi Pi
= 1P1 + 2P2 + 3P3 + 4P4 + 5P5 +………………
= 0.10 + 2 × 0.15 + 3 × 0.25 + 4 × 0.30 + 5 × 0.20 = 3.35
 Average number of replacement per week = N / (Mean Age) = 1000/3.35 = 299
 Average cost of weekly individual replacement policy = Rs 299
(Since the cost of individual replacement of a bulb cost Rs 1)
Now we consider the case of group replacement

End of week Total cost of group Replacement in Rs Average cost per week in Rs
1 1000 × 0.25 + 100 × 1 = 350 350
2 1000 × 0.25 + (100 + 160) × 1 = 510 255
3 1000 × 0.25 + (100 + 160 + 281) × 1 = 791 263.66
Thus, the minimum cost per week is Rs 255.00 if the bulbs are replaced as a group after
every two weeks and this cost is also less than the average cost of weekly individual
replacement policy.
Hence for minimum monthly cost all the bulbs should be replaced after every two weeks.