Replacement Theory

Module 6

replacement
The problem of replacement is felt when the job performing units such as men Machine Equipments Parts etc.. Become less effective or useless due to either sudden or gradual deterioration in their efficiency, failure or breakdown By replacing them with new ones at frequent intervals maintenance and other overhead cost can be reduced

Types of failure
There are two types of failure Gradual failure Sudden failure

Gradual failure cases

Increased running costs ( maintenance + operating cost) Decrease in productivity Decrease in the resale or salvage value

Sudden failure cases

This type of failure occurs in items after some period of giving desired service rather than deteriorating while in service

MODEL 1

Replacement of items whose running cost increases with time and value of money remains constant during a period

ATCn = TC/n
Where TC = C-S+ R(n) Where n = Replacement age of equipment C = Capital or purchase cost of equipment S = Scrap (salvage ) value of the equipment at the end of t years R(n) = Running cost of the equipment TC = Total Cost ATC = Average Total Cost After determining the ATCn find out which year the value of ATCn is minimum which means it is the appropriate time for replacement

E.g.:
1. A firm is considering replacement of a machine, whose cost price is Rs 12,200, and the scrap value Rs 200.The running( maintenance and operating) costs are found from the experience to be as follows:
Year
Running cost (Rs)

1
200

2
500

3
800

4
1200

5
1800

6
2500

7
3200

8
4000

When the machine should be replaced?

Soln.
Year of service n Running cost R(n) (Rs) Cumulative running cost R(n) (Rs) 200 700 1500 Depreciation cost C-S (Rs) Total Cost TC (Rs) Average Cost ATCn (Rs)

1 2 3

200 500 800

12000 12000 12000

12200 12700 13500

12000 6350 4500

4
5 6 7

1200
1800 2500 3200

2700
4500 7000 10200

12000
12000 12000 12000

14700
16500 19000 22200

3675
3300 3167 3171

4000

14200

12000

26200

3275

MODEL 2
Replacement policy for items whose running cost increases with time but value of money changes with constant rate during the period

d=

100 100+r

Where d is the discount rate or depreciation value r is the rate of change

E.g.:
Let the value of the money be assumed to be 10 per cent per year and suppose that machine A is replaced after every 3 years where as machine B is replaced after every 6 years. the yearly cost (In Rs) of both the machines are given as under:
Year Machine A Machine B 1 1000 1700 2 200 100 3 400 200 4 1000 300 5 200 400 6 400 500

Determine which machine should be purchased?

The discounted cost (present worth) at 10 percent rate for machine A and machine B is given below Discounted cost of Machine A
Year Discounted cost at 10% rate (Rs) Cost present worth 1000 1*1000 1000.00

2
3

200
400

200* ( 100/(100+10)
400*(100/100+10)2
=0.9091 Total

181.82
330.56
Rs 1512.38

Hence the average yearly cost of machine A is 1512.38/3=Rs 504.13

Discounted cost of machine B

Year
1 2 3 4 5

Discounted cost at 10% rate(Rs)

cost 1700 100 200 300 400 Present Worth 1700*1 100*0.9091 200*0.8264 300*0.7513 400*0.6830 1700.00 90.91 165.28 225.39 273.20

500

500*0.6209
Total

310.45
Rs 2765.23

The average yearly cost of machine B is 2765.23/6=Rs 460.87

 With the data on average yearly cost of both machines , the apparent advantage is in purchasing machine B .but the periods for which the costs are considered are different . There fore , let us first calculate total present worth of machine A for 6 years Total present worth =1000+200*0.9091+400*0.8264+1000*0.7513+200* 0.6830+400*0.6209=Rs 2648.64 Which is less than the total present worth of machine B . Thus machine A should be purchased