Replacement Models

Prepared by Dr. Sonia Mari

 Replacement Problems

• In Industries, all equipments are put to continuous use which reduces the efficiency of
the equipment. The study of replacement is concerned with situations that arise when
some items such as machines, electric-light bulbs, etc., need replacement due to their
deteriorating efficiency, failure or breakdown.

• The deteriorating efficiency or complete breakdown may be either gradual or all of a

sudden. In all such situations, there is a need to formulate a most economic
replacement policy for replacing faulty units or to take some remedial special action
to restore the efficiency of deteriorating units.
• A replacement is also needed for the equipment if the cost incurred in operating and
maintaining the equipment exceeds the benefit derived out of it.

• The objective of the Replacement problem is therefore to determine the optimal

time at which the equipment is to be replaced with new one.
 Types of Replacement Problem

• Replacement problems, in general, are of three types.

1. Replacement of items that deteriorate with time.

2. Replacement of items that break down completely, and
3. Replacement of items that becomes out of date due to new developments.
 Replacement Models in OR

• In operations research, replacement models are used to make decisions about

replacing or repairing equipment, machinery, or systems over time.
• These models aim to optimize maintenance policies by balancing the costs of
replacement, maintenance, and downtime with the benefits of improved reliability and
performance.
• Here are some common types of replacement models used in operations research:
1. Replacement of Equipment with Minimal Repair:
• In this model, decisions are made regarding whether to replace a piece of equipment
when it fails or to repair it.
• Factors such as repair costs, replacement costs, downtime, and the remaining useful
life of the equipment are considered.
• The goal is to minimize the total cost, which includes repair and replacement costs as
well as any associated downtime costs.
• Example: A company owns a delivery truck that requires occasional repairs due to
wear and tear. Each repair costs $500, and the truck has an estimated useful life of 10
years. The company must decide whether to continue repairing the truck when it
breaks down or to replace it with a new one costing $20,000.
2. Group Replacement Models:
• Group replacement models involve replacing multiple units of equipment
simultaneously at certain intervals.
• This approach is often used when equipment failures are correlated or when it is more
cost-effective to replace several units at once rather than individually.
• Group replacement policies aim to optimize the timing and size of replacement groups
to minimize total costs.
• Example: An airline operates a fleet of aircraft engines, and it is more cost-effective to
replace multiple engines at once rather than individually. The airline decides to
replace all engines in a particular aircraft model every 5 years, regardless of
individual engine failures.
3. Age-Based Replacement Models:
• Age-based replacement models involve replacing equipment based on its age or
usage.
• Decision criteria may include the equipment's expected lifespan, depreciation
schedule, maintenance costs, and the potential for technological obsolescence.
• The objective is to determine the optimal replacement time that balances the costs of
continued operation with the benefits of upgrading to newer equipment.
• Example: A municipality maintains a fleet of buses used for public transportation. The
buses have a lifespan of 15 years, after which they become too costly to maintain. The
municipality decides to replace each bus when it reaches 15 years of age.
4. Condition-Based Replacement Models:
• Condition-based replacement models use the observed condition or performance of
equipment to guide replacement decisions.
• Sensors, monitoring systems, or predictive maintenance techniques are employed to
assess the health and deterioration of equipment.
• Replacement decisions are based on predefined thresholds or criteria related to the
equipment's condition, reliability, or performance metrics.
• Example: A manufacturing plant uses conveyor belts to transport materials. Sensors
are installed on the conveyor belts to monitor their condition. When the sensors detect
excessive wear or imminent failure, the conveyor belts are replaced to avoid
unexpected downtime and production losses.
5. Sequential Replacement Models:
• Sequential replacement models consider a sequence of replacement decisions over
time for a set of interconnected or interdependent components.
• These models account for the impact of replacement decisions on the performance
and reliability of the entire system.
• The goal is to develop optimal replacement policies that maximize system reliability
or minimize total lifecycle costs.
• Example: A power plant operates multiple turbines, and the failure of one turbine can
affect the performance and reliability of the entire plant. The plant implements a
sequential replacement policy, replacing turbines in a specific order based on their
age, usage, and criticality to ensure optimal plant performance and minimize
downtime.
6. Warranty and Maintenance Contract Optimization:
• In some cases, replacement decisions may be influenced by warranties or
maintenance contracts that cover repair and replacement costs.
• Optimization models are used to determine the most cost-effective warranty or
maintenance contract terms and the optimal timing of replacements within the
contract period.
• Example: A company purchases a maintenance contract for its computer servers,
which covers repair and replacement costs for a specified period. The company must
decide whether to renew the maintenance contract each year or to replace the servers
with newer models. The decision is based on the cost-effectiveness of the
maintenance contract compared to the cost of purchasing new servers.
• By employing these replacement models, organizations can effectively manage their
assets, minimize downtime, control maintenance costs, and ensure the reliability and
availability of critical equipment and systems. These models help operations
managers make informed decisions about when and how to replace or repair assets to
achieve their operational and financial objectives.
O.R Methodology of Solving Replacement Problems
Replacement of items that Deteriorates with Time (without change in
money value)
• The objective here is to determine the optimum replacement age of an equipment/
item whose running/maintenance cost increases with time and the value of money
remains static during that period.
• Solution: An optimum replacement policy suggest that replace the equipment at the
end of n years, if the average total cost in the (𝑛 + 1)𝑡ℎ year is more than the average
total cost in the 𝑛𝑡ℎ year and the 𝑛𝑡ℎ year’s maintenance cost is less than the previous
year’s average total cost.
• Let C = Capital Cost of Equipment,
• S= scrap value of equipment
• n = number of years that equipment would be in use
• f (t) =maintenance cost function and,
• Tave = Average total annual cost.
Replacement of items that Deteriorates with Time (without change in
money value)
 Replacement of equipment that deteriorates gradually

• Generally, the cost of maintenance and repairing of certain equipments increases with
time and ultimately the cost may become so high that it is more economical to replace
theses equipments with new ones.
• If the productivity of equipment decreases with time, this may also be considered as a
failure. At this point a replacement is justified.
• The costs associated with aging increase at an increasing rate whereas the resale value
of the equipment decreases at increasing rate.
• The decreasing resale value results in increasing depreciation, which is the difference
between the purchase price and the resale value. The depreciation of the item
increases at a decreasing rate.
• The optimal replacement policy for such items is to replace the equipment at a point
where the total cost curve intersects the total depreciation curve.
Time value of money does not change
• If the value of money does not change with time, then the user of the equipment does
not need to pay interest on his investments. We wish to determine the optimal time to
replace the equipment.
Notations
 Scrap value
Scrap value refers to the residual or salvage value of an asset at the end of its useful life.
To calculate the scrap value of an asset, you typically follow these steps:

➢ Determine the Useful Life: Estimate how long the asset will be useful to your business or
how many years it will be in service.
➢ Estimate Depreciation: Depreciation is the decrease in the value of the asset over its useful
life. There are several methods to calculate depreciation, such as straight-line depreciation,
declining balance depreciation, or units of production depreciation. Choose the appropriate
method for your asset.
➢ Calculate the Depreciated Value: Subtract the accumulated depreciation from the original
cost of the asset to find its current value. This value represents the asset's book value at the
end of its useful life.
➢ Determine Scrap Value: The scrap value is the amount you expect to receive when you sell
or dispose of the asset at the end of its useful life. This value is usually an estimate based on
market conditions, the condition of the asset, and any salvageable parts.
➢ Adjustment: If the asset's estimated scrap value differs from its book value after
depreciation, you may need to make an adjustment to reflect the actual expected value at the
end of its useful life.
• Here's a simple formula to calculate the scrap value:
Scrap Value = Book Value - Depreciation

• Remember, scrap value estimation involves some degree of uncertainty, so it's essential to
make reasonable assumptions and periodically reassess those assumptions as conditions
change.
let's say you have a piece of machinery that you purchased for $10,000, and you
estimate its useful life to be 5 years with no salvage value. You decide to use the
straight-line depreciation method.

• Determine Useful Life: 5 years

• Calculate Depreciation per Year: Since it's straight-line depreciation, you divide the
initial cost by the useful life:
• Depreciation per Year = $10,000 / 5 = $2,000 per year
• Calculate Scrap Value: Assuming no salvage value, the scrap value is zero.
• Calculate Book Value at End of Useful Life: Subtract the total depreciation from the
initial cost:
• Book Value = Initial Cost - Total Depreciation
= $10,000 - ($2,000 * 5)
= $10,000 - $10,000
= $0
• In this example, since there is no salvage value and straight-line depreciation is used,
the scrap value is zero. However, if you expect to sell the machinery for some amount
at the end of its useful life, you would incorporate that value as the scrap value into
the calculation.
Let's modify the previous example to include a non-zero scrap value.
Let's say the same machinery has a scrap value of $1,000 at the end of its useful
life.
• Determine Useful Life: 5 years
• Calculate Depreciation per Year: Again, using straight-line depreciation:
• Depreciation per Year = $10,000 / 5 = $2,000 per year
• Calculate Scrap Value: Given as $1,000
• Calculate Book Value at End of Useful Life: Subtract the total depreciation from the
initial cost:
• Book Value = Initial Cost - Total Depreciation
= $10,000 - ($2,000 * 5)
= $10,000 - $10,000
= $0
• However, since there is a scrap value of $1,000, we need to adjust the final
calculation:
• Adjusted Scrap Value = Scrap Value - (Useful Life * Annual Depreciation)
• = $1,000 - (5 * $2,000)
• = $1,000 - $10,000
• = -$9,000
• In this case, the adjusted scrap value is negative, which doesn't make sense
practically. It indicates that the scrap value is higher than the total depreciation,
which means you would actually make a profit by disposing of the asset.

• So, if you were to consider the $1,000 scrap value, you might need to reassess your
depreciation method or scrap value estimate to ensure it aligns with realistic
expectations.
Problem #1
 Problem # 2

Machine A costs Rs. 45,000/- and the operating costs are

estimated at Rs. 1000/- for the first year, increasing by Rs.
10,000/- per year in the second and subsequent years. Machine B
costs Rs.50000/- and operating costs are Rs. 2000/- for the first
year, increasing by Rs. 4000/- in the second and subsequent years.
If we now have a machine of type A, should we replace it by B? If
so when? Assume both machines have no resale value and future
costs are not discounted.
Machine A

• Here the minimum average annual cost of Machine A is Rs. 26000. Therefore the
Machine A can be replaced at the end of third year.
Problem #3
• Capital cost C = Rs 3800
• Year end trade-in value is S
• Running cost f(t) = operating cost + annual maintenance cost
 Problem # 4

• At what age is the replacement due?

Problem # 5
Problem # 6