1.

Define / Meaning of Replacement Theory

The Replacement Theory is concerned with the prediction of replacement costs,
and the determination of the most economical replacement policy. The prediction
of costs for a group of items with a stochastic life span, for example, light bulbs,
radio tubes, etc., involves estimation of the probability distribution of life spans
and calculation from the predicted number of failures which is a function of the
age of the group of items.

2. Causes of Replacement Theory

The problem of replacement is experienced in systems (both men and machines)
where the efficiencies of items (machine tools, vehicles, capital assets,
individual, etc.) worsen over their lifespan or sometimes fail completely. The
prediction of costs involve those factors which contribute to increased operating
cost, forced idle time, increased scrap, repair cost, etc. in such cases, the item is
to be restored to a previous level by some kind of remedial action
(maintenance). The alternative to the increased cost of operating, an aging
equipment is the cost of replacing the old equipment with a new one, i.e. a stage
is reached at which the replacement of the old item is more profitable than
continuation with the old one at the increased maintenance cost. At that age, the
saving from the use of the new equipment compensates more than its initial
cost.
It is evident that the study of Replacement is a field of application rather than a
method of analysis and is chiefly concerned with the methods of comparing
alternative replacement policies. In fact, uncertainty is present in virtually all
replacement decisions due to unknown future events, such as revenue streams,
maintenance costs, and inflation.

3. Decisions Using Replacement Theory

One of the most practical and typical areas of engineering economics is
replacement analysis. It is assumed that maintenance and replacement decisions
occur on a periodic basis. The decision-maker chooses from various options,
such as to keep, overhaul, or perform preventive maintenance on the existing
asset or replace it with a new / used asset. Any sequence of aforesaid decisions
is called a replacement policy, and any sequence that optimizes some
performance measure, such as net present value or annual equivalent cost, is an
optimal replacement policy.
A general replacement policy indicates the best period of replacement from the
financial point of view. If the item under consideration is a heavy capital
intensive equipment with little resale value, such as generator, it should be used
as long as possible, until the maintenance cost becomes excessively high. A
capital item with a significant resale value such as a car, should be replaced
keeping the resale value in mind. The inexpensive items such as light bulbs can
even be replaced before they are totally burnt out for administrative
convenience.
Financial consideration is not the only guideline for determining the optimum
period of replacement. It may depend upon several other considerations, such as
available funds for investment by the firm policies of the government, policy of
the company, attitude of the employees, accuracy and intricacies of the
components and so on. In a sense, each replacement problem is unique in
nature, having some special feature of its own. Operations research methods
which present a unified approach to the replacement problem, can only be
helpful in a limited way.