Module 4

Replacement Policy/Theory
Introduction
• In any establishment, sooner or later equipment needs to be replaced,
particularly when new equipment gives more efficient or economical service than
the old one.
• In some cases, the old equipment might fail and work no more or is worn out. In
such situations it needs more expenditure on its maintenance than before.
• The problem in such situation is to determine the best policy to be adopted with
respect to replacement of the equipment.
• The replacement theory provides answer to this question in terms of optimal
replacement period.
• Replacement theory deals with the analysis of materials and machines which
deteriorate with time and fix the optimal time of their replacement so that total
cost is the minimum.
Introduction
• During the maintenance period, there may be the requirement of
only minor repairs or maintenance, but there could also be the
requirement of replacement of parts (components), sub-
assemblies or assemblies.
• 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.
Introduction
• Some Examples:
• 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.
• A building in which production activities are carried out, may
leave cracks in walls, roof etc., and needs repair.
• 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
Replacement Decisions
• The problem is to decide the best policy to adopt with regard to
replacement.
• The need for replacement arises in a number of different following
situations so that different types of decisions may have to be taken.
• It may be necessary to decide whether to wait for a certain item to fail
which might cause some loss or to replace earlier at the expense of higher
cost of the item.
• The item can be considered individually to decide whether to replace now
or if not when to reconsider the item in question.
• It is necessary to decide whether to replace by the same item or by a
different type of item.
Cost Associated With Maintenance
• Purchase Cost (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.
• 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.
Cost Associated With Maintenance
• Running costs including maintenance, Repair and Operating
costs - R:
• 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.
Types of Replacement Problems
i. Replacement policy for items, efficiency of which declines
gradually with time without change in money value.
ii. Replacement policy for items, efficiency of which declines
gradually with time but with change in money value.
iii. Replacement policy of items breaking down suddenly
a. Individual replacement policy
b. Group replacement policy
iv. Staff replacement
Replacement policy for items, efficiency of which
declines gradually with time without change in money
value.
• A firm is thinking of replacing a particular machine whose cost
price is ₹12,200. The scrap value of the machine is ₹200/-. The
maintenance costs are found to be as follows. Determine when the
firm should get the machine replaced.

Year 1 2 3 4 5 6 7 8
Maintenance Cost in (₹) 220 500 800 1200 1800 2500 3200 4000
Replacement policy for items, efficiency of which
declines gradually with time without change in money
value.
Given:
Running Cost (in the table)
Scrap Value – S = ₹200
Cost of Machine – C = ₹12, 200
In order to determine the optimal time n when the machine should
be replaced, we first calculate the average cost per year during the
life of the machine, as shown in the table:
 R, S, D, Tc and ATc are in ₹

Year R Cumulative R S Depreciation Cost = D = C-S Total Cost (Tc) Average Cost (ATc)
a b c d e f=c+e =f÷a
1 220 220 200 12000 12220 12220
2 500 720 200 12000 12720 6360
3 800 1520 200 12000 13520 4506.67
4 1200 2720 200 12000 14720 3680
5 1800 4520 200 12000 16520 3304
6 2500 7020 200 12000 19020 3170
7 3200 10220 200 12000 22220 3174.28
8 4000 14220 200 12000 26220 3277.5

• It may be noted that the average cost per year, ATC is minimum in the sixth year (₹ 3170).
• Also the average cost in seventh year (₹ 3,174.28) is more than the cost in the sixth year.
• Hence, the machine should be replaced after every six years.
Replacement policy for items, efficiency of which
declines gradually with time without change in money
value.
• The maintenance cost and resale value per year of a machine
whose purchase price is ₹ 7000 is given below. When should the
machine be replaced?

Year 1 2 3 4 5 6 7 8

Maintenance cost (₹) 900 1200 1600 2100 2800 3700 4700 5900

Resale value (₹) 4000 2000 1200 600 500 400 400 400
 R, S, D, Tc and ATc are in ₹

Year R Cumulative R S Depreciation Cost = D = C-S Total Cost (Tc) Average Cost (ATc)
a b c d e f=c+e =f÷a
1 900 900 4000 3000 3900 3900
2 1200 2100 2000 5000 7100 3550
3 1600 3700 1200 5800 9500 3166.67
4 2100 5800 600 6400 12200 3050
5 2800 8600 500 6500 15100 3020
6 3700 12300 400 6600 18900 3150
7 4700 17000 400 6600 23600 3371.43
8 5900 22900 400 6600 29500 3687.5

• It may be noted that the average cost per year, ATC is minimum in the fifth year (₹ 3020).
• Also the average cost in sixth year (₹ 3,150) is more than the cost in the fifth year.
• Hence, the machine should be replaced after every five years.
Replacement policy for items, efficiency of which
declines gradually with time but with change in money
value.
• Assume that present value of one rupee to be spent in a year’s time is
₹0.90 and the purchase price is ₹3000. The running cost of the equipment
is given in the table below. When should the machine be replaced?

Year 1 2 3 4 5 6 7

Maintenance cost (₹) 500 600 800 1000 1300 1600 2000
 R, S, D, Tc and WATc are in ₹; C = ₹3000

Year R Discount Factor (d) Discounted Maintenance Total Cumulative Cost (Tc) Cumulative d Weighted Average Cost (WATc)

a b c d = b*c e f =e÷f
1 500 1.00 500 3500 1.00 3500
2 600 0.9 540 4040 1.90 2126.31
3 800 0.81 648 4688 2.71 1729.9
4 1000 0.73 730 5418 3.44 1575
5 1300 0.66 858 6276 4.10 1530.73
6 1600 0.59 944 7220 4.69 1539.44
7 2000 0.53 1060 8280 5.22 1586.21

• It may be noted that the weighted average cost per year, WATC is minimum in the fifth year
(₹ 1530.73).
• Also the average cost in sixth year (₹ 1539.44) is more than the cost in the fifth year.
• Hence, the machine should be replaced after every five years.
Replacement policy of items breaking down suddenly.

• A system consists of 10000 electric bulbs. When any bulb fails, it is

replaced immediately and the cost of replacing a bulb individually is
₹1 only. If all the bulbs are replaced at the same time, the cost per
bulb will be ₹0.35. The percent surviving i.e. S (t) at the end of
month ‘t’ and P (t) the probability of failure during the month ‘t’ are
as given below. Find the optimum replacement policy.

‘t’ in months 0 1 2 3 4 5 6

S (t) 100 97 90 70 30 15 0

P (t) --- 0.03 0.07 0.20 0.40 0.15 0.15

Replacement policy of items breaking down suddenly.

• The problem is to be solved in two stages: (i) Policy of individual

replacement and (ii) Policy of group replacement.
• As per the given data, we can see that no bulb will survive for more
than 6 months. That is, a bulb which has survived for 5 months is
sure to fail during the sixth month.
• Though we replace the failed bulb immediately, it is assumed that
the bulb fails during the month will be replaced just at the end of
the month.
• Let Ni = Number of bulbs replaced at the end of ith month, then we
can calculate different values of Ni
Replacement policy of items breaking down suddenly.

N0 N0          
N1 N0 P1          
N2 N0 P2 N 1 P1        
N3 N0 P3 N 1 P2 N 2 P1      
N4 N0 P4 N 1 P3 N 2 P2 N3 P1    
N5 N0 P5 N 1 P4 N 2 P3 N3 P2 N4 P1  
N6 N0 P6 N 1 P5 N 2 P4 N3 P3 N4 P2 N5 P1
Replacement policy of items breaking down suddenly.

N0 = number of bulbs in the beginning = 10,000

N1 = number of bulbs being replaced by the end of first month
= N0P1 = 10,000 * 0.03 = 300
N2 = number of bulbs being replaced by the end of second month.
= N0P2 + N1P1 = 10,000 * 0.07 + 300 * 0.30 = 709
N3 = N0P3 + N1P2 + N2P1
=10,000 * 0.20 + 300 * 0.07 + 709 * 0.03 = 2,042
Replacement policy of items breaking down suddenly.

N4 = N0P4 + N1P3 + N2P2 + N3P1

=10,000 * 0.40 + 300 * 0.20 +709 * 0.07 + 2,042 * 0.03 = 4,171
N5 = N0P5 + N1P4 + N2P3 + N3P2 + N4P1
= 10,000 * 0.15 + 300 * 0.40 + 709 * 0.20 + 2,042 * 0.07 + 4,171 * 0.03 =
2,030
N6 = N0P6 + N1P5 + N2P4 + N3P3 + N4P2 + N5P1
= 10,000 * 0.15 + 300 * 0.15 + 709 * 0.40 + 2,042 * 0.20 + 4,171 * 0.07 +
2,030 * 0.03 = 2,590
Replacement policy of items breaking down suddenly.

•From
  the values of Ni(i= 0, 1,2, …, 6) so calculated, it can be seen that the
expected number of bulbs failing each month increases up to the fourth month
and then starts decreasing and later increases in the sixth month. Thus Ni will
oscillate till the system acquires a steady state.
The expected life of each resistor is given by:
Expected life =
= 1 * 0.03 + 2 * 0.07 + 3 * 0.20 + 4 * 0.40 + 5 * 0.15 + 6 * 0.15
= 4.02 months.
Replacement policy of items breaking down suddenly.

•Individual
  Replacement:
Average number of failures per month is:

= = 2487.56 ≈ 2488

Hence, the total cost of individual replacement at the cost of Re 1 per bulb will be (2,488 * 1) =
₹2,488.
 Replacement policy of items breaking down suddenly.
Group Replacement:
The cost of replacement of all the bulbs at the same time can be calculated as
follows:
Average Cost per
End of Month Total Cost of Group Replacement (₹) Month (₹)
1 (300 * 1) + (10,000 * 0.35) = 3,800 3,800.00
2 (300 + 709) * 1 + (10,000 * 0.35) = 4,509 2,254.50
3 (300 + 709 + 2,042) * 1 + (10,000 * 0.35) = 6,551 2,183.66
4 (300 + 709 + 2,042 + 4,171) * 1 + (10,000 * 0.35) =10,722 2,680.50
5 (300 + 709 + 2,042 + 4,171 + 2,030) * 1+ (10,000 * 0.35) = 12,752 2,550.40
6 (300 + 709 + 2,042 + 4,171 + 2,030 + 2590) * 1 + (10,000 * 0.35) = 15,442 2,557.00

Since the average cost per month of ₹2,183.66 is obtained in the third month, it is optimal to have a
group replacement after every third month.
Additional Problems

• The following table gives the running costs per year and resale
price of a certain equipment whose purchase price is ₹5000.
When should the machine be replaced?

YEAR 1 2 3 4 5 6 7 8

RUNNING COST 1500 1600 1800 2100 2500 2900 3400 4400

RESALE ALUE 3500 2500 1700 1200 800 500 500 500
Additional Problems

• The cost of a machine is ₹61000 and its scrap value is ₹ 1000.

The maintenance cost found from past experience are as follows.
When should the machine be replaced?

YEAR 1 2 3 4 5 6 7 8

MAINTENANCE COST 1000 2500 4000 6000 9000 12000 16000 20000
Additional Problems

• A manufacturer is offered two machines A and B. Machine A is

priced at ₹5,000 and its running costs are estimated at ₹ 800 for
each of the first five years increasing by ₹ 200 per year in the sixth
and subsequent years. Machine B that has the same capacity as A,
costs ₹2,500 but would have running costs of ₹1,200 per year for
six years, increasing by ₹200 per year thereafter. If money is worth
10 per cent per year, which machine should be purchased?
(Assume that the machine will eventually be sold for scrap at a
negligible price)
Additional Problems

• Assume that present value of one rupee to be spent in a year’s time is

₹0.90 and the purchase price is ₹5000. The running cost of the equipment
is given in the table below. When should the machine be replaced?

Year 1 2 3 4 5 6 7

Maintenance cost (₹) 400 500 700 1000 1300 1700 2100
Additional Problems

• The following mortality rates have been observed for a special type of light
bulbs. In an industrial unit there are 1,000 special types of bulbs in use. The
cost ₹10 to replace an individual bulb that has burn out. If all bulbs were
replaced simultaneously It would cost ₹2.50 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 of time
should the manager replace all the bulbs?

Month 1 2 3 4 5

Percent failing at the end of the month 10 25 50 80 100

Additional Problems

• Find the cost per period of individual replacement of installation of 300 light
bulbs, given the following :
• Cost of replacing individual bulb is ₹3
• Conditional probability of failure is given below:

Week Number 0 1 2 3 4
Conditional Probability of Failure 0 0.1 0.2 0.4 0.3
Additional Problems

• The following mortality rates have been observed for a certain type of fuse :

Week Number 1 2 3 4 5
Percentage failing by end of week 5 15 35 75 100

• There are 1,000 fuses in use and it costs ₹5 to replace an individual fuse. If all
fuses were replaced simultaneously it would cost ₹1.25 per fuse. It is
proposed to replace all fuses at fixed intervals of time, whether or not they
have burnt out, and to continue replacing burnt out fuses as they fail. At what
time intervals should the group the group replacement be made? Also prove
that this optimal policy is superior to the straight forward policy of replacing
each fuse only when it fails
Additional Problems

• The following mortality rates have been observed for a special type of light bulbs:

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

• In an industrial unit there are 1,000 special types of bulbs in use. The cost
₹10 to replace an individual bulb that has burn out. If all bulbs were replaced
simultaneously It would cost ₹2.50 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 of time should the
manager replace all the bulbs?
Additional Problems

• A computer has 20,000 resistors. When any of the resistors fails, it is

replaced. The cost of replacing a resistor individually is ₹1. If all the
resistors are replaced at the same time the cost per resistor is
reduced to ₹0.40. The percentage surviving at the end of month ‘t’,
and the probability of failure during a month , are given below. Find
the optimum replacement policy.

‘t’ in months 0 1 2 3 4 5 6

Percentage of Surviving at the end of ‘t’ -S (t) 100 96 90 65 35 20 0

Probability of failure during the month ‘t’ -P (t) --- 0.04 0.06 0.25 0.30 0.15 0.20
Q&A
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