Replacement of Assets that Deteriorate with Time

This model is represented by:

• Increasing maintenance cost.

• Decreasing salvage value.

Assumption

• Increased age reduces efficiency

Generally, the criteria for measuring efficiency is the discounted value of all future costs
associated with each policy.

Let
C = the capital cost of a certain item, say a machine
S(t) = the selling or scrap value of the item after t years.
F(t) = operating cost of the item at time t
n = optimal replacement period of the time

Now, the annual cost of the machine at time t is given by C – S(t) + F(t) and since the total
maintenance cost incurred on the machine during n years is F(t) dt, the total cost T, incurred
on the machine during n years is given by:

T = C – S(t) + F(t) dt

Thus, the average annual total cost incurred on the machine per year during n years is given by

1
TA = —– C – S(t) + F(t) dt
n

To determine the optimal period for replacing the machine, the above function is differentiated
with respect to n and equated to zero.

dTA -1 -1 F(n)
—— = —– C – S(t) —– F(t) dt + ——
dn n2 n2 n

dTA
Equating —— = 0, we get
dn
 1
F(n) = —– C – S(t) + F(t) dt
n

That is, F(n) = TA

Example

The initial cost of a machine is Rs. 7100 and scrap value is Rs. 100. The maintenance costs
found from experience are as follows:

Year 1 2 3 4 5 6 7 8

Maintenance 200 350 500 700 1000 1300 1700 2100

When should the machine be replaced?

Solution.

Differen
ce Averag
Cumulati Scra Average
Runnin between e Average
Yea ve p investme
g initial runnin annual
r running valu nt cost /
cost cost and g cost / total cost
cost e year
scrap year
value

G= H=F
A B C D E F = E/A
C/A +G

1 200 200 100 7000 7000 200 7200

200 + 350
2 350 100 7000 3500 225 3775
= 550

550 + 500 2683.3

3 500 100 7000 2333.33 350
= 1050 3
 1050 +
2187.5
4 700 700 = 100 7000 1750 437.5
0
1750

1750 +
5 1000 1000 = 100 7000 1400 550 1950
2750

2750 +
1841.6
6 1300 1300 = 100 7000 1166.67 675
7
4050

4050 +
1821.4
7 1700 1700 = 100 7000 1000 821.42
2
5750

5750 +
1856.2
8 2100 2100 = 100 7000 875 981.25
5
7850

This table shows that the average annual total cost during the seventh year is minimum. Hence,
the machine should be replaced after the 7th year.

Replacement of Assets which Fail Suddenly

In some situations, failure of a certain item occurs all of a sudden, instead of gradual
deterioration (e.g., failure of light bulbs, tubes, etc.).

The failure of the item may result in complete breakdown of the system. The breakdown
implies loss of production, idle inventory, idle labour, etc. Therefore, an organization must
prepare itself against these failures.

“Failure to prepare is preparing to fail.” – Ben Franklin

Thus, to avoid the possibility of a complete breakdown, it is desirable to formulate a suitable

replacement policy. The following two courses can be followed in such situations.
• Individual replacement policy. Under this policy, an item may be replaced immediately after
its failure.
• Group replacement policy. Under this policy, the items are replaced in group after a certain
period, say t, irrespective of the fact that items have failed or not. If any item fails before its
preventive replacement is due, then individual replacement policy is used.

In situations where the items fail completely, the formulation of replacement policy depends
upon the probability of failure. Mortality tables or Life testing techniques may be used to obtain
a probability distribution of the failure of items in a system.

Mortality Tables

M(t) = Number of items surviving at time t

M(t – 1) = Number of items surviving at time (t – 1)
N = Total number of items in the system

The probability of failure of items during the interval t and (t – 1) is given by

M(t – 1) – M(t)
—————-
N

The conditional probability that any item survived upto age (t – 1) and will fail in the next
period is given by

M(t – 1) – M(t)
—————-
M(t – 1)

Example 1
Following mortality rates have been observed for certain type of light bulbs.

Time (weeks) 0 1 2 3 4 5 6 7 8 9 10

Number of bulbs still operating 100 94 82 58 40 28 19 13 7 3 0

Calculate the probability of failure.

Solution.

Here, t is the time (weeks) and M (t) is the number of bulbs still operating. The probability of
failure can be calculated as shown in the following table.
Table

Probability of failure
Time
M (t) pi = [ M (t – 1)- M (t) ] /
(t)
N

0 100 —-

1 94 (100 – 94)/100 = 0.06

2 82 (94 – 82)/100 = 0.12

3 58 (82 – 58)/100 = 0.24

4 40 (58 – 40)/100 = 0.18

5 28 (40 – 28)/100 = 0.12

6 19 (28 – 19)/100 = 0.09

7 13 (19 – 13)/100 = 0.06

8 7 (13 – 7)/100 = 0.06

9 3 (7 – 3)/100 = 0.04

10 0 (3 – 0)/100 = 0.03

Example 2
Following mortality rates have been observed for a certain type of electronic component.

Month 0 1 2 3 4 5 6
 % surviving at the end of the month 100 97 90 70 30 15 0

There are 10000 items in operation. It costs Re 1 to replace an individual item and 35 paise per
item, if all items are replaced simultaneously. It is decided to replace all items at fixed intervals
& to continue replacing individual items as and when they fail. At what intervals should all
items be replaced? Assume that the items failing during a month are replaced at the end of the
month.

Solution.

Probability of
% surviving at the end of the
Month failure
month
pi

0 100 —-

1 97 (100 – 97)/100 = 0.03

2 90 (97 – 90)/100 = 0.07

3 70 (90 – 70)/100 = 0.20

4 30 (70 – 30)/100 = 0.40

5 15 (30 – 15)/100 = 0.15

6 0 (15 – 0)/100 = 0.15

The given problem can be divided into two parts.

1. Individual replacement.
2. Group replacement.

Case I

It should be noted that no item survives for more than 6 months. Thus, an item which has
survived for 5 months is sure to fail during sixth month.
The expected life of each item is given by

= Σ xipi, where xi is the month and pi is the corresponding probability of failure.

= (1 X 0.03) + (2 X 0.07) + (3 X 0.20) + (4 X 0.40) + (5 X 0.15) + (6 X 0.15)
= 4.02 months.

∴ Average number of replacement every month = N/(average expected life) = 10000/4.02 =

2487.5
= 2488 items (approx.).
Here average cost of monthly individual replacement policy = 2488 X 1 = Rs. 2488/-, (the cost
being Re 1/- per item).

Case II

Let Ni denote the number of items replaced at the end of ith month.

Calculating values for Ni

N0 = Number of items in the beginning = 10,000

N1 = Number of items during the 1st month X probability that an item fails during 1st month of
installation
= 10000 X 0.03 = 300

N2 = Number of items replaced by the end of second month

=(Number of items in beginning X probability that these items will fail in 2 month) + (Number
nd

of items replaced in first month X probability that these items will fail during second month)

=N0P2 + N1P1
=(10000 X 0.07) + (300 X 0.03) = 709

N3 = N 0P 3 + N1P2 + N2P1
= (10000 X 0.20) + (300 X 0.07)+ (709 X 0.03) = 2042

N4 = N0P4 + N1P3 + N2P2+ N3P1

= (10000 X 0.40) + (300 X 0.20)+ (709 X 0.07) + (2042 X 0.03) = 4171

N5 = N0P5 + N1P4 + N 2P 3+ N3P2+ N4P1

= (10000 X 0.15) + (300 X 0.40)+ (709 X 0.20) + (2042 X 0.07) + (4171 X 0.03) = 2030

N6 = N0P6 + N1P5 + N2P4+ N 3P 3 + N4P2 + N5P1

= (10000 X 0.15) + (300 X 0.15)+ (709 X 0.40) + (2042 X 0.20) + (4171 X 0.07) + (2030 X
0.03) = 2590.

From the above calculations, it is observed that Ni increases upto fourth month and then
decreases. It can also be seen that Ni will later tend to increase and the value of Ni will oscillate
till the system acquires a steady state.
The optimum replacement cycle under group replacement is given in the following table.

Total Cost of Cost of all Average

End Cumulative Total
no. of replacement replacement cost per
of no. of cost
items after failure (Rs. 0.35/ month
month failure (Rs.)
failed (Re 1/ item) item) (Rs.)

1 300 300 300 3500 3800 3800

2 709 1009 1009 3500 4509 2254.50

3 2042 3051 3051 3500 6551 2183.66

4 4171 7222 7222 3500 10722 2680.50

5 2030 9252 9252 3500 12752 2550.40

6 2590 11842 11842 3500 15342 2557.00

The above table shows that the average cost during the third month is minimum. Thus, it would
be economical to replace all the items every three months.

Meaning of Networking

Meaning of Network Technique

Network technique is a technique for planning, scheduling (programming) and controlling the
progress of projects. This is very useful for projects which are complex in nature or where
activities are subject to considerable degree of uncertainty in performance time.

This technique provides an effective management, determines the project duration more
accurately, identifies the activities which are critical at different stages of project completion
to enable to pay more attention on these activities, analyse the scheduling at regular interval
for taking corrective action well in advance, facilitates in optimistic resources utilisation, helps
management for taking timely and better decisions for effective monitoring and control during
execution of the project.
 Objectives of Network Analysis:
Network analysis entails a group of techniques for presenting information relating to time and
resources so as to assist in the planning, scheduling, and controlling of projects. The infor-
mation, usually represented by a network, includes the sequences, interdependencies, interre-
lationships, and criticality of various activities of the project.

A network analysis has following objectives:

1. Powerful tool of planning, scheduling and control.

2. Shows the inter-relationships of the activities of a project or a programme.
3. Minimises total cost where the cost of delays and cost of resources required to carry out the tasks can
be measured.
4. Minimise total time where required e.g. in maintenance of production-line machinery in a factory.
5. Minimization of idle resources.
6. Minimise production delays.
7. To provide systematic approach in planning and scheduling.
8. Follow an integrated approach and bring about better coordination between the departments.
9. Focusses attention on critical activities of the project.
10. Provides up-to-date status information.
11. Suggest areas for increasing efficiency, and reduction of cost.

Applications of Network Technique:

Applications of network techniques are very wide, but are very common in some of the
following fields:

(i) Planning,

(ii) Construction of buildings, bridges, highways, railways, stadiums, irrigation projects,

factories, power projects etc.

(iii) Assembly line scheduling,

(iv) Development and launching of new products,

(v) Strategic and tactical military planning,

(vi) Research and development,

(vii) Market penetration programmes,

(viii) Planning of political campaigns,

(ix) Maintenance and overhauling of complicated or large machineries,

(x) organising big conferences etc.

Advantages of Network Technique:

Main advantages of the network system are as follows:
1. Detailed and thoughtful planning provides better analysis and logical thinking.
2. Identifies the critical activities and focus them to provide greater managerial attention.
3. Network technique enables to forecast project duration more accurately.
4. It is a powerful tool for optimisation of resources by using the concept of slack.
5. It provides a scientific basis for monitoring, review and control, to evaluate effect of slippages.
6. It helps in taking decision;

(i) To over-come delays,

(ii) To crashing programme,

(iii) Optimising resources, and

(iv) On other corrective actions.

7. It helps in getting better co-ordination amongst related fields.

8. It is an effective management tool through a common and simple language, providing common
understanding.

Limitations of Network Techniques:

Network techniques have following limitations:

(i) Network technique is simply a tool to help the management; hence its effectiveness depends
on how well it is used by the management.

(ii) Its accuracy depends on the estimation of the data used in the network.

(iii) It is useful only if it is updated regularly and decisions for corrective actions are taken
timely.

Analysis with the help of PERT and CPM

Program Evaluation and Review Technique (PERT) is a method used to examine the
tasked that are in a schedule and determine a variation of the Critical Path Method (CPM).
It analyzes the time required to complete each task and its associated dependencies to
determine the minimum time to complete a project. It estimates the shortest possible time
each activity will take, the most likely length of time, and the longest time that might be
taken if the activity takes longer than expected.

The method was developed by the US Navy in 1957 on the Polaris nuclear submarine
project.
To conduct PERT Analysis, three time estimates are obtained (optimistic, pessimistic, and
most likely) for every activity along the Critical Path. Then use those estimates in the
formula below to calculate how much time for each project stage:
 Formula: (P+4M+O)/6

• Optimistic Time (O):the minimum possible time required to accomplish a task, assuming
everything proceeds better than is normally expected.
• Pessimistic Time (P):the maximum possible time required to accomplish a task,
assuming everything goes wrong (excluding major catastrophes).
• Most likely Time (M): the best estimate of the time required to accomplish a task,
assuming everything proceeds as normal.

Example of the three time estimates

Example of a Critical Path Nodal Diagram

PERT Analysis can be conducted using Microsoft Project.

Critical Path Method

The Critical Path is the longest path of scheduled activities that must be met in order to
execute a project. This is important for Program Managers (PM) to know since any
problems that occur on the critical path can prevent a project from moving forward and be
delayed. Earned Value Management (EVM) analysis focuses on the critical path and near
critical paths to identify cost and schedule risks. Other schedule paths might have slack
time in them to avoid delaying the entire project unlike the critical path. There might be
multiple critical paths on a project.
 The Critical Path is determined when analyze a projects schedule or network logic diagram
and uses the Critical Path Method (CPM). The CPM provides a graphical view of the
project, predicts the time required for the project, and shows which activities are critical to
maintain the schedule.

The seven (7) steps in the CPM are: [1]

1. List of all activities required to complete the project (see Work Breakdown Structure
(WBS)),
2. Determine the sequence of activities
3. Draw a network diagram
4. Determine the time that each activity will take to completion
5. Determine the dependencies between the activities
6. Determine the critical path
7. Update the network diagram as the project progresses

The CPM calculates the longest path of planned activities to the end of the project, and
the earliest and latest that each activity can start and finish without making the project
longer. This process determines which activities are “critical” (i.e., on the longest path)
and which have “total float” (i.e., can be delayed without making the project longer). [1]

The CPM is a project modeling technique developed in the late 1950s by Morgan R.
Walker of DuPont and James E. Kelley, Jr. of Remington Rand.

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Resource Planning and Meaning of Crashing

Resource Planning
Resource planning refers to the strategy for planned and judicious utilisation of resources.
Resource planning is essential for sustainable existence of all forms of life.
 Resource planning is essential for India as there is enormous diversity in the availability of
resources. For example the state of Rajasthan has vast potential for the development of solar
and wind energy but is deficient in water resources.

The cold desert of Ladakh has rich cultural heritage but is deficient in water and some strategic
minerals.

The state of Arunachal Pradesh has abundance of water resources but lacks infrastructure which
shows mere availability of resources in the absence of technology and institutions hinders
development.

This shows that the resource planning is needed at the national, regional, state and local levels
for balanced development of a country.

Meaning of Crashing

Crashing is a schedule compression technique used to reduce or shorten the project schedule.

The PM can various measures to accomplish this goal. Some of the common methods used are

• Adding additional resources to the critical path tasks

This option has various constraints such as the securing of the budget to add the resources, and
the availability of the resources.
• Reduce the project requirements or scope
This can be done only if the sponsor and major stakeholders agree to reduce the scope

After applying the crashing, the critical path might have changed and result in creating a
different critical path. Always revisit the project schedule to ensure the schedule has been
crashed.

Other Definitions

1. Crashing is the technique to use when fast tracking has not saved enough time on the schedule.
It is a technique in which resources are added to the project for the least cost possible. Cost and
schedule tradeoffs are analyzed to determine how to obtain the greatest amount of compression
for the least incremental cost.
2. Crashing refers to a particular variety of project schedule compression which is performed for
the purposes of decreasing total period of time (also known as the total project schedule
duration). The diminishing of the project duration typically take place after a careful and
thorough analysis of all possible project duration minimization alternatives in which any and
all methods to attain the maximum schedule duration for the least additional cost.
3. When we say that an activity will take a certain number of days or weeks, what we really mean
is this activity normally takes this many Project Management Triangle days or weeks. We could
make it take less time, but to do so would cost more money. Spending more money to get
something done more quickly is called “crashing”. There are various methods of project
schedule crashing, and the decision to crash should only take place after you’ve carefully
analyzed all of the possible alternatives.The key is to attain maximum decrease in schedule
time with minimum cost.
4. Crashing the schedule means to throw additional resources to the critical path without
necessarily getting the highest level of efficiency.
5. Crashing is another schedule compression technique where you add extra resources to the
project to compress the schedule. In crashing, you review the critical path and see which
activities can be completed by adding extra resources. You try to find the activities that can be
reduced the most by adding the least amount of cost. Once you find those activities, you will
apply the crashing technique.