Replacement Problems

Introduction:-
The replacement problems are concerned with the situations that arise when some items such as men,
machines and usable things etc need replacement due to their decreased efficiency, failure or breakdown.
Such decreased efficiency or complete breakdown may either be gradual or all of a sudden.
If a firm wants to survive the competition it has to decide on whether to replace the out dated equipment
or to retain it, by taking the cost of maintenance and operation into account. There are two basic reasons
for considering the replacement of equipment.

(i) Physical impairment or malfunctioning of various parts.

The physical impairment refers only to changes in the physical condition of the equipment itself. This will
lead to decline in the value of service rendered by the equipment, increased operating cost of the
equipments, and increased maintenance cost of the equipment or the combination of these costs.

(ii) Obsolescence of the equipment.

Obsolescence is caused due to improvement in the existing Tools and machinery mainly when the
technology becomes advanced therefore; it becomes uneconomical to continue production with the same
equipment under any of the above situations. Hence the equipments are to be periodically replaced.
Sometimes, the capacity of existing facilities may be in adequate to meet the current demand. Under such
cases, the following two alternatives will be considered.
1. Replacement of the existing equipment with a new one
2. Argument the existing one with additional equipments.

Type of Maintenance
Maintenance activity can be classified into two types
i) Preventive Maintenance –
Preventive maintenance (PN) is the periodical inspection and service which are aimed to detect potential
failures and perform minor adjustments a requires which will prevent major operating problem in future.

ii) Breakdown Maintenance

Breakdown maintenance is the repair which is generally done after the equipment breaks down. It is offer
an emergency which will have an associated penalty in terms of increasing the cost of maintenance and
downtime cost of equipment, Preventive maintenance will reduce such costs up-to a certain extent.

Beyond that the cost of preventive maintenance will be more when compared to the cost of the breakdown
maintenance.
Total cost = Preventive maintenance cost + Breakdown maintenance cost.

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This total cost will go on decreasing up-to P with an increase in the level of maintenance up-to a point,
beyond which the total cost will start increasing from P. The level of maintenance corresponding to the
minimum total cost at P is the Optional level of maintenance this concept is illustrated in the follows
diagram:-

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Types of Replacement Problem
The replacement problem can be classified into two categories.

i) Replacement of assets that deteriorate with time (replacement due to gradual failure, due to wear
and tear of the components of the machines) this can be further classified into the following types.
a) Determination of economic type of an asset.
b) Replacement of an existing asset with a new asset.
ii) Simple probabilistic model for assets which will fail completely (replacement due to sudden
failure).

Determination of Economic Life of an asset

Any asset will have the following cost components
i) Capital recovery cost (average first cost), Computed form the first cost (Purchase price) of the
asset.
ii) Average operating and maintenance cost.
iii) Total cost which is the sum of capital recovery cost (average first cost) and average operating and
maintenance cost.

A typical shape of each of the above cost with respect to life of the asset is shown below

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From figure, when the life of the machine increases, it is clear that the capital recovery cost (average first
cost) goes on decreasing and the average operating and maintenance cost goes on increasing. From the
beginning the total cost goes on decreasing up to a particular life of the asset and then it starts increasing.
The point P was the total cost in the minimum is called the Economic life of the asset. To solve problems
under replacement, we consider the basics of interest formula.
Present worth factor denoted by (P/F, i,n). If an amount P is invested now with amount earning interest at
the rate i per year, then the future sum (F) accumulated after n years can be obtained.
P - Principal sum at year Zero
F - Future sum of P at the end
th
of the n year
i - Annual interest rate
n - Number of interest periods.
Then the formula for future sum F = P ( 1 + i ) n

P = F/(1 +i)n = Fx (present worth factor)

If A is the annual equivalent amount which occurs at the end of every year from year one through n years
is given by
A = P x i (1 +i)n
(1 +i)n - 1
= P ( A / P, i, n )
= P x equal payment series capital recovery factor

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Example:-
A firm is considering replacement of equipment whose first cost is Rs. 1750 and the scrap value is
negligible at any year. Based on experience, it is found that maintenance cost is zero during the first year
and it increases by Rs. 100 every year thereafter.
i) When should be the equipment replaced if (a) i = 0% & (b) i = 12%Solution :

Solution:
Given the first cost = Rs 1750 and the maintenance cost is Rs. Zero during the first years and then
increases by Rs. 100 every year thereafter. Then the following table shows the calculation.

Calculations to determine Economic life

(a) First cost Rs. 1750 Interest rate = 0%

Summation Average cost Average first Average total

Maintenan
End of of of cost if cost through
ce cost at
year (n) maintenanc maintenance replaced at the
end of year
e through the the given given year
Cost given year year and
A B (Rs) C (Rs) D (in Rs) E (Rs) F (Rs)
1750
C= B C/A D+E
A
1 0 0 0 1750 1750
2 100 100 50 875 925
3 200 300 100 583 683
4 300 600 150 438 588
5 400 1000 200 350 550
6 500 1500 250 292 542
7 600 2100 300 250 550
8 700 2800 350 219 569

The value corresponding to any end-of-year (n) in Column F represents the average total cost of using the
equipment till the end of that particulars year.

In this problem, the average total cost decreases till the end of the year 6 and then it increases.
Hence the optimal replacement period is 6 years i.e. the economic life of the equipment is 6 years.

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(b) When interest rate i = 12%
When the interest rate is more than 0% the steps to get the economic life are summarized in the following
table.
Calculation to determine Economic life
First Cost = Rs. 1750 Interest rate = 12%
Mai Present Summation
En nten worth as of present Present (A/P,
d ance beginning worth of simulator 12%,n) Annual
of cost of years maintenanc maintena =i (1+i) n
equipment
ye at (P/F,12v,n) 1 of e costs nce cost (1+i) -1 n
total cost
ar end maintenanc through the and first through the
(n) of e costs given year cost giver year
year G
s
A B C D E F G H
C=
B 1 BxC D E+ FxG
n
(iR) (1+12/100) Rs. 1750
1 0 0.8929 0 0 1750 1.1200 1960
2 100 0.7972 79.72 79.72 1829.72 0.5917 1082.6
3 200 0.7118 142.36 222.08 1972.08 0.4163 820.9
4 300 0.6355 190.65 412.73 2162.73 0.3292 711.9
5 400 0.5674 226.96 639.69 2389.69 0.2774 662.9
6 500 0.5066 253.30 892.99 2642.99 0.2432 642.7
7 600 0.4524 271.44 1164.43 2914.430 0.2191 638.5
8 700 0.4039 282.73 1447.16 3197.16 0.2013 680.7
Identify the end of year for which the annual equivalent total cost is minimum in column. In this problem
the annual equivalent total cost is minimum at the end of year hence the economics life of the equipment
is 7 years.

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 Simple probabilistic model for items which completely fail

Electronic items like bulbs, resistors, tube lights etc. generally fail all of a sudden, instead of gradual
failure. The sudden failure of the item results in complete breakdown of the system. The system may
contain a collection of such items or just an item like a single tube-light. Hence we use some replacement
policy for such items which would minimize the possibility of complete breakdown. The following are
the replacement policies which are applicable in these cases.

i) Individual replacement policy: - Under this policy, each item is replaced immediately after failure.
ii) Group replacement policy:- Under group replacement policy, a decision is made with regard the
replacement at what equal internals, all the item are to be replaced simultaneously with a provision to
replace the items individually which fail during the fixed group replacement period.

Among the two types of replacement polices, we have to decide which replacement policy we have to
follow. Whether individual replacement policy is better than group replacement policy. With regard to
economic point of view. To decide this, each of the replacement policy is calculated and the most
economic one is selected for implementation.

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Assignment
1. List and explain different types of maintenance
2. Discuss the reasons for maintenance.
3. Distinguish between breakdown maintenance and preventive maintenance.
4. Distinguish between individual and group replacement polices.
5. A firm is considering replacement of equipment whose first cost is Rs.4000 and the scrap value is
negligible at the end of any year. Based on experience, it has been found that the maintenance cost
is zero during the first year and it is Rs.1000 for the second year. It increases by Rs.300 every year
thereafter.
a) When should the equipment be replace if i = 0%
b) When should the equipment be replace if i = 12%
Ans . a) 5 years b) 5 years
6. A company is planning to replace an equipment whose first cost is Rs.1,00,000. The operating and
maintenance cost of the equipment during its first year of operation is Rs.10,000 and it increases
by Rs. 2,000 every year thereafter. The release value of the equipment at the end of the first year
of its operation is Rs.65,000 and it decreases by Rs.10,000 every year thereafter. Find the
economic life of the equipment by assuming the interest rate as 12%.
[Ans : Economic life = 13 years and the corresponding annual equivalent cost = Rs. 34,510]

7. The following table gives the operation cost; maintenance cost and salvages value at the end of
every year of machine whose purchase value is Rs. 12,000. Find the economic life of the machine
assuming.
a) The interest rate as 0%
b) The interest rate as 15%
Operation cost at Maintenance cost Salvage value at the end
End of
the end of year at the end of year of year (Rs)
year
(Rs) (Rs)
1 2000 2500 8000
2 3000 3000 7000
3 4000 3500 6000
4 5000 4000 5000
5 6000 4500 4000
6 7000 5000 3000
7 8000 5500 2000
8 9000 6000 1000

Ans :
a) Economic life of the machine = 2 years
b) Economic life of the machine = 2 years

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