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Replacement Theory
The problem of replacement arises when any one of the components of productive resources, such as
machinery, building and men deteriorates due to time or usage. The examples are:
(a ) A machine, which is purchased and installed in a production system, due to usage some of its
components wear out and its efficiency is reduced.
(b ) A building in which production activities are carried out, may leave cracks in walls, roof etc, and
needs repair.
(c ) A worker, when he is young, will work efficiently, as the time passes becomes old and his work
efficiency falls down and after some time he will become unable to work.

In general, when any production facility is new, it works with full operating efficiency and due to usage
or of time, it may become old and some of its components wear out and the operating efficiency of the
facility falls down. To regain the efficiency, a remedy by, namely maintenance is to be attended. The act
of maintenance consists of replacing the worn out part, or oiling or overhauling, or repair etc. In modern
industrial scene, the presence of highly sophisticated machinery in manufacturing system will bother
the manager, when any one of the facilities goes out of order or breakdown. Because of the breakdown
of one of the facility, the entire production system may be affected. This is particularly true in batch
manufacturing system and continuous manufacturing system. The loss of production hours is more
expensive factor for the manufacturing unit. Hence, the management must take interest in maintain the
production facility properly, so that facility's available time will be more than the down time. All the
production facilities are subjected to deterioration due to their use and exposure to the environmental
conditions. The process of deterioration, if unchecked or neglected, it culminates and makes the facility
useless. Hence, the management has to check the facilities periodically, and keep all the facilities in
operating condition. Once the maintenance is attended, the efficiency may not be regained to previous
level but a bit less than that of previous level. For example, if the operating efficiency is 95 percent and
due to deterioration, the efficiency reduces to 90 percent, after maintenance, it may regain to the level of
93 percent. Once again due to usage the efficiency falls down and the maintenance is to be attended. This
is an ongoing business of the management. After some time, the efficiency reduces to such a level, the
maintenance cost will become very high and due to less efficiency the unit production cost will be very
high and this is the time the management has to think of replacing the facility. This may be well
explained by means of a figure.

100
95

Productive 75
Efficiency in %
50
Replacement
25

1 2 3 4 5 6
Time
Referring to above, the operating efficiency at the beginning is 95%. When first maintenance is attended,
it is reduced to 93%. In the second maintenance it is reduced to 80 percent. Like this the facility
deteriorates, and finally the operating efficiency reduces to 50 percent, where the it is not economical to
use the facility for further production, as the maintenance cost will be very high, and the unit production
cost also increases, hence the replacement of the facility is due at this stage. In this chapter, we will
discuss the mathematical models used for finding the optimal replacement time of facilities.
Thus the problem of replacement is experienced in systems where machines, individuals or capital
assets are the main production or job performing units. The characteristics of these units is that
their level of performance or efficiency decreases with time or usage and one has to formulate
some suitable replacement policy regarding these units to keep the system up to some desired level
of performance. We may have to take different type of decision such as:

(a ) We may decide whether to wait for complete failure of the item (which may result in some losses
due to deterioration or to replace earlier at the expense of higher cost of the item,

(b ) The expensive item may be considered individually to decide whether we should replace now or, if
not, when it should be reconsidered for replacement,
(c ) Whether the item is to be replaced by similar type of item or by different type for example item with
latest technology

The problem of replacement is encountered in the case of both men and machines. Using probability, it
is possible to estimate the chance of death or failure at various ages. The main objective of
replacement is to help the organization for maximizing its profit or to minimize the cost.
FAILURE MECHANISM OF ITEMS

The word failure has got a wider meaning in industrial maintenance than what it has in our daily life. We
can categorize the failure in two classes. They are (i ) Gradual failure and (ii ) Sudden failure. Once again
the sudden failure may be classified as: (a ) Progressive failure, (b ) Retrogressive failure and (c )
Random failure.

(i ) Gradual failure:
In this class as the life of the machine increases or due continuous usage, due to wear and tear of
components of the facility, its efficiency deteriorates due to which the management can experience: (a)
Progressive Increase in maintenance expenditure or operating costs, (b) Decreased productivity of the
equipment and (c) decrease in the value of the equipment i.e. resale value of the equipment/facility
decreases.
Examples of this category are: Automobiles, Machine tools, etc.
(ii ) Sudden failure:
In this case, the items ultimately fail after a period of time. The life of the equipment cannot be predicted
and is some sort of random variable. The period between installation and failure is not constant for any
particular type of machine but will follow some frequency distribution, which may be:
(a ) Progressive failure: In this case probability of failure increases with the increase in life of an item.
The best example is electrical bulbs and computer components

(b) Retrogressive failure: Some items will have higher probability of failure in the beginning of their life,
and as the time passes chances of failure becomes less. That is the ability of the item to survive in the
initial period of life increases its expected life. The examples are newly installed machines in production
systems, new vehicles, and infant baby (The probability of survival is very less in infant age, but once the
baby get accustomed to nature, the probability of failure decreases).

(c) Random failure: In this class, constant probability of failure is associated with items that fail from
random causes such as physical shocks, not related to age. In such cases all items fail before aging has
any effect.
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Bathtub Curve
Machine or equipment or facility life can be classified into three stages. They are Infant stage, Youth
stage or Youth phase and Old age stage or Old age phase.
a ) Infant stage or phase

This is also known as early failure stage. When new equipment is purchased and installed in the existing
system, it has to cope up with the operating efficiency of the existing system. Also it has to accustom to
operating skill of the operator. Perhaps when a new vehicle is purchased, due to mechanical conditions
of the machine and the operating skill of the person, the vehicle may give trouble in the early stages. The
owner may have to visit the mechanic many times. It is like a baby, which has come out from mother's
womb. The baby until birth, it was in a controlled atmosphere and when the birth takes place, it has to
get accustom to outside atmosphere. Hence it cries. Sometimes there is a danger of failure of life. Hence
we see more failures in infant stage. Once an age of 10 to 15 years is reached, the death rate or failure
rates will reduce. In this stage the safety of machine is covered by the guarantee period given by the
manufacturer. This is represented by a curve on the left hand side of the Bathtub curve.

(b ) Youth stage or random failure stage

In this stage the equipment or machine is accustomed to the system in which it is installed and works at
designed operating efficiency. Regular maintenance such as overhauling, oiling, greasing, cleaning keep
the machine working. Now and then due to wear and tear of components or heavy load or electrical
voltage fluctuations, breakdown may occur, which can be taken care of by repair maintenance. The
machine or equipment works for longer periods without any trouble. This is like youth stage in human
life that is full of vigor and energy and the person will be healthy and work for longer periods without
any diseases. This is shown as a horizontal line in bathtub curve. Here repair maintenance; preventive
maintenance or other maintenance techniques are used to keep the machine or equipment in working
condition.

(c ) Old age stage or Old age phase or Wear out failures

Due to continuous usage and age of the machine, there will be wear and tear of various components. Not
only this, during youth stage, some of the components might have been replaced due to wear and tear.
These replaced components may not suit well in the system if they are not from original manufacturer.
As the manufacturers are changing the design, one has to go for spares available in the market. All this
may reduce to operating efficiency of the machine or equipment and the management has to face
frequent failures. This is very similar to old age in human life. Due to old age, people will get diseases
and old age weakness and many a time they have to go to hospitals for treatment before the life fails.
This is shown on the right side of the bath- tub curve. Here one will think of replacement of the
equipment or machine. When all the above three curves are assembled, we get a curve which is in the
form of a bathtub and is known as bathtub curve.

Chance of
Failure

Initial Stage Youth Stage Old Age Stage

Follow Manufacturer's Breakdown maintenance, Repairs, Replace or scrap or
instructions Preventive maintenance to be used recondition
 Summary of three stages of maintenance
Type of Suitable maintenance
Phase Failure Rate Causes of Failure Costs
Failure Policy
Faulty design, Erratic
Warrantee and
Early Decreasing operations, Installation Medium to
Infant Guarantee by
Failures Trend Errors, Environmental high
manufacturer
Problems
Random or
Operational Errors, Break down, predictive,
chance low to
Youth Constant Heavy Load, Shifts and preventive repairs and
failures or medium
over runs maintenance
rare
Wear out
Operate to fail
or age
Increasing Wear, tear, creep and corrective maintenance
Old Age failure due High
Trend fatigue etc. or otherwise
to wear
replacement
and tear
Costs Associated with Maintenance
Our main aim in this chapter is to find optimal replacement period so as to minimize the maintenance
cost. Hence we are very much interested in the various cost associated with maintenance. Various costs
to be discussed are:
(a ) Purchase cost or Capital cost: ( C )
This cost is independent of the age of the machine or usage of the machine. This is incurred at the
beginning of the life of the machine, i.e. at the time of purchasing the machine or equipment. But the
interest on the invested money is an important factor to be considered.
(b ) Salvage value / Scrap value / Resale value / Depreciation: (S)
As the age of the machine increases, the resale value decreases as its operating efficiency decreases and
the maintenance costs increases. It depends on the operating conditions of the machine and life of the
machine.
(c ) Running costs including maintenance, Repair and Operating costs:
These costs are the functions of age of the machine and usage of the machine. As the usage increases or
the age increases, due to wear and tear, many components fail to work and they are to be replaced. As
the age increases, failures also increase and the maintenance costs goes on increasing. At some period
the maintenance costs are so high, which will indicate that the replacement of the machine or equipment
is essential.

Total Costs

Running Costs
Minimum
Total Costs
Costs
in Rupees Cost of Optimum
Purchase

Scrap Value

Age of Machine
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TYPES OF REPLACEMENT PROBLEMS
One must remember that the study of Replacement of items is a field of application rather than a
method of analysis. The study involves, the comparison of alternative replacement policies. Various
types of replacement problems we come across in this chapter is:
(a ) Replacement of Capital equipment, which looses its operating efficiency due to aging (passage of
time), or due to continuous usage (due to wear and tear of components). Examples are: Machine tools,
Transport and other vehicles, etc., Here the system can maintain the level of performance by installing a
new unit at the beginning of some unit of time (year, month or week) and decide to keep it up to some
suitable period so as to minimize the operating and maintenance costs. In this case the deterioration
process is predictable and is represented by an increased maintenance cost and decreased in scrap cost
and increased production cost per unit. In such cases the optimum life of the item is determined on the
assumption that increased age reduces efficiency. Deterministic models explain the problem and they
are very much similar to that of inventory models where deterioration corresponds to demand against
the desired level of efficiency (level of inventory). The cost of new item is similar to cost of
replenishment of inventory and maintenance cost corresponds to cost of holding inventory.
These types of problems are solved by two methods. They are:
(i ) By calculating the cost per unit of time, without considering the money value. Here we calculate the
total cost up to the period and divide by time unit (years, months, weeks etc.,) to find the average cost to
decide the period of replacement.
(ii ) By taking the money value into consideration using present value concept to compare on a one
number basis.
(b ) Replacement of items that fail completely all in a sudden in a random nature. We use Group
replacement or Preventive maintenance technique for these items and these are expensive to
replace individually. Examples are: Electric bulbs, Transistors, Electronic components etc., Here
replacement of items are done in anticipation of failure, which is known as preventive maintenance.
We assume that the items will have relatively constant efficiency until they fail or die. These models
require the knowledge of statistics and stochastic process involving probability of failure. The
replacement policy is formulated to balance the wasted life of items replaced before failure against the
costs incurred when items fail in service.
(c ) Replacement of human beings in organizations, known as Staffing problem, or known as Human
resource planning or Mortality and Staffing problem. This problem requires the knowledge of life
distribution for service of staff in a system.
(d ) Miscellaneous problems such as replacement of existing units due to availability of more effective
and new and advanced technology. In these problems replacement will become necessary due to
research of new and advanced and more effective technology and old technology becomes out of date.
GENERAL APPROACH TO SOLUTION TO REPLACEMENT PROBLEM
Though it is not possible or it is difficult to predict the time of failure of an item exactly, likely failure
pattern could be established by observation. Generating the probability distribution for the given
situation and then using them in conjunction with relevant cost information we can formulate the
optimum replacement policy. The information necessary to formulate optimum replacement policy is:

(i ) Objective assessment of the probability of the item failing at a particular point of time
(ii ) Assessments of the cost of replacement in terms of:
(a ) Actual cost of the item,
(b ) Direct costs of labour involved in replacement,
(c ) Costs of disruption in terms of lost production, lost orders etc.,
 REPLACEMENT OF ITEMS WHOSE EFFICIENCY REDUCES OR MAINTENANCE COST INCREASES
WITH TIME OR DUE TO AGE AND MONEY VALUE IS NOT CONSIDERED
Costs to be considered: Various cost items to be considered in replacement decisions are the costs that
depend upon the choice or age of item or equipment. The costs those do not change with the age of the
machine or item need not be taken into consideration. The replacement of items whose efficiency
reduces with time is justified when the average cost per time period goes on reducing longer the
replacement is postponed. However, there will come an age at which the rate of increase of running
costs more than compensates the saving in average capital costs. At this age the replacement is justified.
In the case of replacement of items whose efficiency deteriorates with time, the most important criteria
to be considered is the measurement of efficiency. Consider a machine, in this case, the maintenance cost
always increases with time and usage and a time comes when the maintenance cost becomes large
enough, which indicates that it is better and economical to replace the machine with a new one. When
we want to replace the machine, we may come across various alternative choices, where we have to
compare the various cost elements such as running costs and maintenance costs to select optimal
choice. The various techniques we may come across to analyse the situation are:

(a ) Replacement of items whose maintenance cost increases with time and value of money remains
same during the period,
(b ) Replacement of items whose maintenance cost increases with time and the value of money also
(c ) To compare alternative choices, use of concept of present value.
Principles for replacement
1. When the time is measured in discrete units, replacing the machine when the next period's
maintenance cost becomes greater than the current average cost will minimize then the average annual
cost.
2. If time is measured continuously, then the average annual costs will be minimized by replacing the
machine or item, when the average cost to date becomes equal to the current maintenance cost.
3. If time is measured in discrete units, then the average annual cost will be minimized by replacing the
machine or item when the next period’s maintenance cost becomes greater than the current average
cost.
Question 1
Viky Industries wishes to replace a particular machine whose cost is Rs. 12,200 and estimated scrap is Rs. 200.
Maintain ace Costs are as follows. Decide when to replace the machine based on avg maintenance costs p.a.
Year 1 2 3 4 5 6 7 8
Costs Rs. 220 500 800 1200 1800 2500 3200 4000
Answer
Year Maintain ace Cumulative Capital Cost Scrap Total Cost Average Cost
n m cm C S C - S + cm TC / n
1 220 220 12200 200 12220 12220.00
2 500 720 12200 200 12720 6360.00
3 800 1520 12200 200 13520 4506.67
4 1200 2720 12200 200 14720 3680.00
5 1800 4520 12200 200 16520 3304.00
6 2500 7020 12200 200 19020 3170.00 Lowest
7 3200 10220 12200 200 22220 3174.29
8 4000 14220 12200 200 26220 3277.50
Decision:
Replace the machine at the end of 6th year as its average annual maintenance cost is the minimum.
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Question 2
Vikrant Industries wishes to replace a particular machine costing Rs. 7,000. Scrap value varies as per use.
Maintenance Costs are as follows. Decide when to replace the machine based on avg maintenance costs p.a.
Year 1 2 3 4 5 6 7 8
Costs Rs. 900 1200 1600 2100 2800 3700 4700 5900
Resale 4,000 2000 1200 600 500 400 400 400
Answer
Year Maintenance Cumulative Capital Cost Scrap Total Cost Average Cost
n m cm C S C - S + cm TC / n
1 900 900 7000 4000 3900 3900.00
2 7000
3 7000
4 7000
5 7000
6 7000
7 7000
8 7000
As the average cost is minimum at the end of the 5th year, the machine should be replaced then.
Question 3
Vikrant Transporters finds from its past records that the cost per year of running a truck and resale value of
such truck whose cost is 6,000,000 is as under. At what stage the replacement should be made ? ( Rs. In '000)
Year 1 2 3 4 5 6 7 8
Costs 1000 1200 100 1800 2300 2800 3400 4000
Resale 3000 1500 750 375 200 200 200 200
Question 4
Kelkar Industries has initial cost of equipment Rs. 3,800. Trade in value is available at the end of each year,
which suggests how much this equipment costs under exchange offer for similar new equipment. Minimum
trade -in is Rs. 600. Maintenance costs are as follows. Find when replacement is due.
Year of Service 1 2 3 4 5
Year End Trade in Value in Rs. 2000 1200 800 700 600
Annual Operating Costs in Rs. 1600 1900 2200 2500 2800
Annual Maintenance Costs in Rs. 400 500 700 900 1100
Answer
Here we have Annual Operating Costs as well as Annual Maintenance Costs. These are to summed up for
finding out Total Running Costs. ( e.g. Running costs for year 1 are Rs. 2000) and then cumulative running costs
should be computed. Similarly capital costs i.e. cost of purchasing new machine at the end of each year will
vary as trade ins are different for each year. For example at the end of the year, if we wish to purchase new
equipment then there is no need to pay Rs. 3800 again as we can avail exchange offer where our machine costs
Rs. 2000 and then we have to pay only 1800 for the sake of buying new machine ( i.e. C in the table ).
Answer
Running
Year Cum R C Cost after Trade in (3800 - Trade in) Total Costs Avg Costs
Cost
n m cm C C + cm TC / n

Question 5
A firm is using a machine whose purchase price is Rs. 13,000. The installation charges are Rs. 3,600.
Machine has scrap value of Rs. 1,600 only as the firm has monopoly of this type of work. Running Costs are:
Year 1 2 3 4 5 6 7 8
Rs. 250 750 1000 1500 2100 2900 4000 4800
The firm wants to determine after how many years should the machine be replaced assuming that the
machine replacement can be done only at the end of the year.
Answer
Year Running cost Cum Costs Cost Scrap Effective Cost Total Cost Avg Cost
n CC C S EC = C - S TC = CC + EC TC / n
1 250 250 16,600 1,600 15,000 15,250 15,250
2
3
4
5
6
7
8
Question 6
What if in Question 5, Scrap value estimated at the end of Year 1 is 12,000. But it decreases @ 20% p.a. on
earlier estimate from year 2 to 6 and then it is constant there after. Rewrite.
Year Running cost Cum Costs Cost Scrap Effective Cost Total Cost Avg Cost
n CC C S EC = C - S TC = CC + EC TC / n
1 250 250 16,600 12,000.00 4,600 4,850 4,850
2 750 1,000 16,600 9,600.00 7,000 8,000 4,000
3 1000
4 1500
5 2100
6 2900
7 4000
8 4800
Remark
Question 7
A machine costs Rs. 5,000. Its maintenance costs Rs. 1,000 in each of the first 4 years and increases by
Rs. 200 every year. Assuming that the machine has no salvage value and the maintenance costs are
incurred in the beginning of the each year, determine the optimum replacement time assuming the time
value of money is @ 10% p.a. Assume life of 12 years.
Answer
Here we have to compute present value factor for maintenance costs @ 10%. As we are paying them in
the beginning of the year, for 1st year pvf will be 1 and for year 2 it will be 0.9091 and so on. So after
computing pv of MC we have to compute Cumulative PV of MC. Important point is when we are going to
compute Average annual costs of running machine, instead of years we have to consider Cumulative
Present Value factor to divide the Total Costs as the costs are Present Values too.
Year Maintenance PVF PV of MC Cum PV Total Costs Cumulative PV of Avg
Costs of MC incurred till PVF Cost
date annualized
i ii iii = i x ii iv =Cum of iii v = 5000 + iv vi v / vi
1 1,000 1 1,000.00 1,000.00 6,000.00 1 6,000.00
2 1,000 0.9091 909.09 1,909.09 6,909.09 1.9091 3,619.05
3 1,000 0.8264 826.45 2,735.54 7,735.54 2.7355 2,827.79
4 1,000 0.7513
5 1,200 0.6830
6 1,400 0.6209
7 1,600 0.5645
8 1,800 0.5132
9 2,000 0.4665
10 2,200 0.4241
11 2,400 0.3855
12 2,600 0.3505