Whenever new equipment offers better service-conditions than HIU replacement the existing one replacement theory can be used. This theory concerns the forecasting of replacement costs and deciding the optimum replacement policy. One of the major applications of this theory is making purchasing decision about existing similar equipment.
Last article on focused on the basics of replacement theory. What we have seen there is that an old item can be replaced by a new purchase at an optimum cost. This optimum cost is the trade-off between the rising maintenance of that item and its declining resale value. Now, let's move a bit further. What happens when time-value of money is considered? It is advisable that the readers should go through the previous article by the author on the basics of replacement theory.
Time-value of money
Time-value of money is the purchasing power of the money over a period of time. You will get lesser gas (fuel) today than ten years back with $ 1000. This means that the value of $1000 is reduced over a period of time. What one could purchase with $1000 few years back cannot do so at present. The factor with which we make this adjustment is called as 'present worth factor' (PWF).
For example: Machines A and B costs $2500 and $1250 respectively. The running (maintenance) cost of Machine-A is $400for the first 5 years and increases by $100 every year thereafter. Similarly, the running cost of Machine-B is $600 for the first 6 years and increases by $100 every year thereafter. Considering the time-value of money depreciates at 10% per year, decide the suitable replacement policy. This type of examples is illustrated at: Replacement with Time-Value of Money.
There are some items which fail completely and unpredictably. In some sudden breakdowns, immediate replacement may not be available. Further, these kinds of items may not have maintenance costs as such but they fail suddenly without any prior warning like fluorescent tubes, light bulbs, electronic chips, fuse and so on. It is found that replacing these random failing items simultaneously at specific intervals is economical as compared to replacing them only when an item fails. A long period between group replacements results in increase in cost of individual replacements, while frequent group replacements are definitely costly. There lies the need to balance this and find an optimum replacement time for optimum cost of replacement. It should be noted that, group replacement does involve periodic simultaneous replacements along with individual replacements in between.
For example: The mortality rates of 10, 15, 25, 30 and 20 per cent have been observed for a special type of light bulbs in the first five months respectively. There are 1000 such bulbs in the concerned unit of the industry. It costs $10 to replace an individual bulb that has burnt out. If the bulbs were replaced simultaneously, it would cost $2.50 per bulb. It is proposed to replace all the bulbs at fixed interval, whether are not they have burnt out, and to continue replacing the burnt out bulbs as they fail. At what intervals of time HIU replacementshould the manager replace all the bulbs? Decide the optimum replacement policy.