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DP 471: ELECTRICAL SAFETY AND MAINTENANCE

LESSON 5: OPTIMAL REPLACEMENT DECISIONS


5. Introduction
Replacement problems are of two types: (1) deterministic, i.e. the timing and outcome of the
replacement action are known with 100% certainty; (2) probabilistic, i.e. the timing and the
outcome of the replacement action depend on chance. In determining when to perform a
replacement we are interested in the sequence of times at which the replacement actions
should take place. Any sequence of times is a replacement policy, but what we are interested in
determining are optimal replacement policies, that is, ones which maximize or minimize some
criterion, such as profit, total cost, downtime, etc.
5.1 Case of equipment with "infinite" lifetime
Assumptions in the models are presented here:
a) the equipment can be used for long lengths of time.
b) probabilistic problems have only two possible conditions (good and failed).
c) replacement actions return the facility to the new condition thus continuing to provide the
same services as the equipment which has just been replaced. Thus various costs, failure
distributions, etc, remain the same.
d) for preventive replacement actions, i.e. ones taken before equipment reaches a failed state,
the following conditions must apply:
- total cost of the replacement must be greater after failure than before.
- the failure rate of the facility must be increasing. This is not the case for negative
exponential and hyper-exponential distribution functions whose failure rates are constant
and decreasing respectively.
It is useful to know that the failure rate of equipment must be increasing before preventive
replacement is worthwhile. Very often when equipment frequently breaks down the immediate
reaction of the maintenance engineer is that the level of preventive replacements should be
increased. If, to start with, he determined the failure distributions of the components being
replaced he would realize whether or not such preventive replacement was applicable. It may
well be that the appropriate procedure is to allow the equipment to breakdown before
performing a replacement. This decision can be made simply by obtaining statistics relevant to
the equipment and does not involve construction of a model to analyze the problem.
Overhaul and repair can be considered to be equivalent to replacement provided it is
reasonable to assume that such actions also return equipment to the as "new condition". In
practice this is often a reasonable assumption and hence the following model for replacement
problems can often be used to analyze overhaul/repair problems.
The problem is to determine the optimal interval between replacement after having noted that:
- deterioration of equipment increases operating costs
- replacing deteriorating parts reduces operating costs
- replacements cost money in terms of materials and wages and increase with replacement
frequency

It is easier to note that there is a trade off between operating and replacement costs. Hence,
there is an optimal replacement frequency per specified period below which operating costs
exceed replacement costs and above which the opposite happens.
The balance between operating and replacement costs can easily be obtained through
determination of an optimal number of replacements within a given study period. Consider the
following planning interval [0, T], in which the replacement policy is to perform Nr equally
spaced replacements at intervals of tr. Cop(t) is the operating cost per unit time at time t after a
replacement, and Cr is the cost of a replacement. The aim here is to find the optimal interval
between replacements such that the overall costs are minimised.

tr

Nr T

Let the total cost Ctot(t), to be a summation of all costs from the start to the end of planning
period (i.e. it includes both the replacement and maintenance operating costs within the
planning interval [0,T]). Therefore Ctot(t) represents a function of the interval between
replacements tr.
To get the total replacement costs within [0, T], the unit cost per replacement Cr will be
multiplied by the number of replacements Nr .
CR =

Nr * Cr

The total operating costs within [0, T] is equivalent to operating cost for each interval between
replacements multiplied by the number of intervals in period [0, T]. (n.b.: The operation cost
mentioned here refers only to maintenance associated operation cost, and has nothing to do at
all with the rest of the production operation cost)
Nr 1

Cop ( tot ) Cop(tr )i

(5.1)

i 1

with:
Cop(tot)
Cop(tr)

total operating costs within interval [0, T]


operating costs in one interval tr.

If it is assumed that tr is an infinitesimal interval (i.e. limit tr0), then equation (5.1) can further
be estimated as:

tr

Cop ( tot ) Nr 1 Copt dt


0

The total cost within the same planning interval [0, T] is then given by the summation of
replacement and operating costs and can be mathematically represented by equation (5.2)
below:

tr
Ctot (t ) NrCr Nr 1 Cop(t ) dt

(5.2)

Note that (Nr + 1)tr = T, therefore Nr = T/ tr - 1, and equation (5.2) above can be rewritten as
follows:

T
T tr
Ctot (t ) Cr Cr Cop(t ) dt
tr
tr 0

(5.3)

To determine the exact form of Cop(t) let us consider the following maintenance related
operation costs model. Cop(t) includes the cost of lost production due to equipment down time,
the cost of reworking faulty workpiece due to a faulty machine, the cost of discarding or
modification of the workpiece and other breakdown associated costs.

Cop(t ) VWsc Cbr * ABtu PNpq * Cret

(5.4)

with:
VW sc

average value of workpieces on operating equipment, which will become


scrap if the equipment accidentally breaks
Cbr
breakdown and breakdown associated costs such as downtime costs,
secondary breakdown costs and the cost of injury of operator if the equipment
accidentally breaks
ABtu
number of accidental breakdowns per unit time
PNpq
amount of poor quality products produced by the equipment per unit time
Cre
reprocessing costs i.e. costs of reworking products with poor quality caused
by faulty equipment.
By substituting equation (5.4) in (5.3), and solving the integral part of the equation (5.3), the
resulting equation is depicted as:

Ctot (t )

TCr
T
Cr * VWsc Cbr * ABtu PNpq * Cre tr
tr
2

(5.5)

Equation (5.5) represents the total cost as a function of tr. The task now is to determine the
optimal value of tr, which will make the total cost Ctot(t) minimum. To obtain this minimum value
of the total cost, equation (5.5) will be differentiated with respect to t r and the resulting
expression will be set to zero to obtain the value of tr (i.e. tr') that minimises the total cost
function. So, by differentiation of equation (5.5), the resulting expression is depicted below as
equation (5.6).

C' tot (t )

TCr T
* VWsc Cbr * ABtu PNpq * Cre
tr 2
2

(5.6)

Equating equation (5.6) to zero and simplifying the expression, it can be shown that:

tr

2Cr
VWsc Cbr * ABtu PNpq * Cre

(5.7)

Equation (5.7) shows that, the optimal preventive replacement interval is dependent only on the
costs' function. That is tr is only dependent on the cost of replacement (i.e. Cr), the average
value of work-in-progress (i.e. VW sc), breakdown and breakdown associated costs (i.e. Cbr),
costs of reworking products with poor quality caused by faulty equipment (i.e. Cre), the amount
of poor quality products produced by the equipment per unit time (i.e. PNpq), and the number of
accidental breakdowns within that unit time (i.e. ABtu). Likewise, the equation is totally
independent of the given study period (i.e. [0, T]), so the equation can be used for a general
purpose analysis of the optimal interval of preventive maintenance action.
To ascertain whether or not tr obtained in equation (5.7) is an optimal interval that makes the
total cost minimum, it is necessary to differentiate again 5.6) with respect to t r (i.e. a second
differential of equation (5.5)), then substitute the value of tr obtained in equation (5.7) in the
resulting expression. The expression should then be evaluated for maximum and minimum
points. By so doing and rearrangement of the resulting solution, the following equation can be
obtained:

T VWsc Cbr * ABtu PNpq Cre


C' tot (t )
4Cr 2

(5.8)

Equation (5.8) is positive for all real values of the given cost functions. This result shows that
the value of tr obtained in equation (5.7) makes the total cost Ctot(t) minimum. The value of tr
obtained here will be taken as an average economic replacement interval for preventive
maintenance actions. The average frequency of replacement (i.e. frequency of preventive
maintenance action), is now the reciprocal of the replacement interval as shown on equation
(5.9).

fpm

tr

VW C * AB PN * C
sc

br

tu

pq

re

2Cr

(5.9)

Equation (5.9) represents the average frequency of preventive maintenance as a square root of
the quotient of maintenance induced operating costs per unit time to the maintenance
replacement cost per replacement.
Sometimes there is not a specific planning period of interest and therefore we are only
interested in determining the optimal interval between successive replacements such that the
total cost of operation plus replacement per unit time is minimized. As before Cop(t) represents
the operating cost while Cr is the cost of a replacement. A replacement is performed at the end
of interval of length tr.
The total cost per unit time C(tr), for replacement at time tr, is:
C(tr) =

total cos t in int erval 0, t r


length of int erval t r

The total cost in interval = cost of operating + cost of replacement

tr

0 Cop(t)dt+

C( t r ) =

1
tr

Cr
(5.10)
tr

[ Cop(t)dt+ C r ]
0

(5.11)

This is a model of the problem relating replacement interval tr to the total cost per unit time C(tr).
In the present modelling effort, the time it takes to make a replacement is omitted, which could
be included as follows:
one replacement cycle time = operation time + replacement time
Hence:

tr

C( t r ) =

0 Cop(t)dt+

Cr

t r + Tr

5.13

The procedure for determining the optimal value of tr remains the same. For practical problems
tR , which is the replacement time, is much smaller that tr and therefore can neglected.
5.2 Maximization of Discounted Benefits
In this section the determination of the optimal replacement interval for capital equipment such
that discounted benefits are maximized will be analyzed.
Assumptions:
- replacement is with an identical equipment, i.e, one with similar costs/benefits behavior
- equipment is operated over long period of time
- replacement is based on maximum discounted benefits
Factors:
b(t) net benefit obtained from the equipment at time t
(revenue at t) - (operating costs at t), b(t) will most likely decrease with t.
c(t) net cost of replacing equipment of age t
made up of such things as:
- purchase cost
- installation cost
- lost production
- minus the salvage value of the used equipment.
i = the relevant interest rate
Tr = time required to replace the equipment
ta = age of the equipment when replacement occurs
tr+Tr = the replacement cycle, i.e., the time from the finish of one replacement action to the
next. During tr operating costs increase while benefits decrease.
B(tr) = the total discounted net benefits derived from operating the equipment for periods of
length tr, over a long time.

For the purpose of the analysis the period over which replacements will occur will be taken as
infinity, although in practice this will not be the case. This does not significantly affect the value
of tr. Only B(tr) is affected.
The objective is to determine the optimum interval between replacements such that the total
discounted net benefits derived from operating the equipment over a long period of time are
maximized.
If we consider the nth cycle of operation, then: the discounted benefits over the cycle
(discounting to the beginning of this cycle) =
tr

b(t) e

-it

dt

5.14

where e-it is a discount factor for the continuous case. and the discounted replacement cost is:

= c( t r ) e-itr

5.15

Hence:
tr

-it
Bn ( t r + T r )= b(t) e dt - c( t r ) e it r

5.16

n = 1,2, 3, ...
Bn(tr + Tr) must be discounted back to the start of the first period, i.e.

-i(n-1)t r+T r

Bn ( t r + T r ) e

5.17

Thus, if we denote (tr + Tr) by T, the total discounted net benefit (i.e. for all cycles), over a long
period of time, with replacement at age tr, is:

B( t r ) = B1(T)+ B2 (T)e-iT + ...+ Bn (T)e-i(n -1)(T) + ...

5.18

Note that B1(T) = B2(T) = .... = Bn(T). Therefore we can replace Bi's with B in the above
equation. The result is a geometrical progression to infinite which gives

B( t r ) =

B(T)
1 - e-i(T)

5.19

and if we replaced B(T) with the expansion for Bn(tr + Tr) we obtain:

tr

Btr

it
itr
bt e dt C tr e
0

5.20

1 e i tr Tr

This is a model of the replacement problem relating the replacement age t r to the total
discounted net benefits.
Procedure for obtaining a solution:
a)
determine/establish b(t) on the basis of historical data or otherwise. For example, b(t)
can be of the form like this: a + b e-kt per year where a, b and k are constants.
b)
determine the time required to perform a replacement i.e. Tr
c)
establish the relevant interest rate i.
d)
substituteall of the above in the equation for B(tr) and complete the integration. B(t) will
now/then be a function of tr with all other quantities fixed.
e)
evaluate B(tr) for various values of tr; plot and observe the pattern to see whether there is
a maximum for B(tr) and indicate when it occurs i.e. the tr corresponding to the max B.
5.3 Minimization of Total Cost:
We now consider the optimal replacement interval for capital equipment while minimizing total
cost. This problem is similar to the previous one except that: (a) the objective is to determine
the replacement interval that minimizes the total cost of maintenance and replacement over a
long period of time; and (b) the trend in cost is taken to be discrete, rather than continuous.
Variables:
A
the acquisition cost of the capital equipment.
Ci
the cost of maintenance in the ith period from new, assumed to be paid at the end of the
period, i = 1, 2, ..., n
Si
the resale value of the equipment at the end of the ith period of operation i = 1, 2, ...., n.
r
the discount rate = 1 / ( 1 + i)
n
the age in periods of the equipment when replaced
C(n) the total discounted cost of maintaining and replacing the equipment (with identical
equipment) over a long period of time with replacements occurring at intervals of n
periods.
Objective:
To determine the optimal interval between replacements such that the total cost is
minimized.
Note: a cycle is divided into n discrete periods (e.g. years) and it starts from just when a facility
is new to when it is replaced.
The total cost in the first cycle (leading to the first replacement):

C1n C1r C 2 r 2 ... Cnr n Ar n Snr n

5.21

i.e.

C1 (n) =

C r + r
i

(A - S n )

5.22

t=1

The total cost in the second cycle, discounted to the start of the second cycle is:
n

C2 (n) =

C r + r
i

(A - S n )

5.23

t=1

The reader can repeat in a similar way for the case of 3rd, 4th etc cycles, each discounted to
the start of each cycle. The total discounted cost, when discounting is taken to the start of
operations, i.e., at time t = 0, is:

C(n) = C1 (n) + C 2 (n) r n +...+ C n (n) r (n-1)n

5.24

Since C1(n) = C2(n) = C3(n) = .... = Cn(n), we have a geometric progression which gives, over an
infinite period:
n

C (n)
C(n) = 1 n =
1- r

C r + r
i

(A - S n )

i=1

1 - rn

5.25

This is a model of the problem relating replacement interval n to total cost.


Solution procedure:
a)
b)
c)
d)
e)
f)

establish A, the acquisition cost. Assume it is the same for all the cycles.
estimate maintenance costs per year for several years in the future.
establish relevant the discount rate r
estimate the resale value for several years in the future
evaluate the expression for C(n) for different values of n. Start with n=1 up to n = several
years approximately the age of the typical old machine.
select the n* giving the minimum value of C(n).

N.B.: - the acquisition cost has been assumed to be constant. Also trends in maintenance costs
are the same after each replacements. This may unrealistic in the face of inflationary pressures.
Furthermore, we do not always replace with new equipment. However, the model can be easily
revised to include these aspects.

5.4 Technological Improvements


Let us now consider the optimal replacement policy for capital equipment taking into account
technological improvements. For there may be a technologically improved equipment on the
market with which to replace the one currently in use. Improvements can be with respect to:
decreased maintenance and operating costs; increased throughput; increased quality of output;
etc.
Variables:
n
the number of operating periods during which equipment will be required (the planning
period).
Cp,i the maintenance cost of the present equipment in the ith period from now, payable at the
time i, i = 1, 2, ..., n
Sp,i the resale value of the present equipment at the end of the ith period from now, i = 0,1,2,
..., n.
Ct,j the maintenance cost of the technologically improved equipment in the jth period after its
installation and payable at time j, j = 1,2, ... , n.
St,j the resale value of the technologically improved equipment at the end of its jth period of
operation, j = 0, 1, 2, --, n. ( j = 0 then St, 0 = A)
r
the discount factor
The objective is to determine that value of T, at which replacement should take place, with the
new equipment, T can be = 0, 1, 2, ... ,n. That is, the replacement can occur at any time within
the period which such equipment is required for service.
The total discounted cost over n periods, with replacement occurring at the end of Tth period
is:
C(T) = discounted maintenance costs for present equipment over period [0,T] plus discounted
maintenance cost for technologically improved equipment over period [T,n] plus
discounted acquisition cost of new equipment, minus discounted resale value of
present equipment at the end of Tth period minus discounted resale value of
technologically improved equipment at the end of nth period.
C(T) =(Cp,1r1 +Cp,2r2 +Cp,3r3 + ...+Cp,TrT)+ ( Ct,1rT+1 +Ct,2rT+2 +...+ Ct,n-Trn)+ ArT -(Sp,T rT + St,n-Trn)
Therefore:
T

n-T

C(T) = C p.i r + ct, j rT + j + Ar T - ( S p ,T r T + S t,n-T r n )


i

i=1

5.27

j=1

This is a model of the problem relating replacement time T to total discounted costs, C(T).
Solution procedure:
a)
establish the number of operating periods to go in the planning period.
b)
estimate maintenance costs Cp,i over the next n periods of using the present quipment.
c)
estimate the trend in resale values of the present equipment payable at the end of the
period, for all of the expected periods, n.
d)
obtain/estimate the acquisition cost of the technologically improved equipment, A.
e)
estimate maintenance cost Ct,j over the next n periods assuming the technologically
improved equipment is used.

f)
g)
h)

estimate the trend in resale value of the technologically improved equipment, payable at
the end of its jth period, of operation, St,j. Do it for all the expected operating periods n.
establish the discount rate r
evaluate C(T) for different values of T, i.e., T = 0, 1, ... , n and observe the value of T
which minimizes the total costs. For example, if the total cost is minimized at T = 0, then
this would mean that the technologically improved equipment should be installed now and
used over all the required periods of operation.

If the minimum cost occurs at T = n this would mean that no replacement would take place and
the present equipment would be used for the remaining n periods of operation. If the minimum
values of C(T) occurs for a value of T between 0 and n then the replacement should occur with
the technologically improved equipment at the end of the Tth period.
Note: It was assumed in the previous model that once a decision was taken to replace with the
technologically improved equipment, no further replacements were made. In some situations
the time during which equipment is required is sufficiently long to warrant further replacements.
Assuming that we continue to use the technologically improved equipment then it is not difficult
to determine its economic life. This is done here now.
Let Cp,i, Sp,i, A, Ct,j, St,i be as before.
The replacement policy is to account for technological improvements under an infinite planning
horizon.
The total cost over a long period of time with replacements of the present equipment at the end
of T periods of operation, followed by replacements of technologically improved equipment at
intervals of n, is:
C(T,n) = costs over interval (0,T)+future costs associated with new equipment over interval
(0,T)
The costs over interval [0, T] i.e. C[0,T] are:
T

C[0,T] =

p,i

i
T
T
r - S p,T r + Ar

5.27

i=1

The future costs, discounted to time T, can be obtained using the previous equation as follows:
n

C
C(n) =

t, j

j
n
r + r (A - S n )

j=1

5.28

1 - rn

Hence, C(n) discounted to time zero is C(n).rT


i.e.:
n

C
*
T
C (n) = r

t, j

j
n
r + r (A - S n )

i=1

1 - rn

5.29

10

C(T,n) = C[0,T] + C*(n) is therefore the model of the problem relating changing over time to
technologically improved equipment, T, and economic life of new equipment, n, to the total
discounted costs C(T,n).
Solution procedure:
a)
obtain data for Cp,i, Sp,i, Ct,j, & St,j as described before.
b)
determine the economic life, n*, of the technologically improved equipment. Hint tabulate
C(n) as a function of n. n* is the value of n corresponding to the smallest value of C(n).
c)
obtain the total discounted cost C(T, n*), for T = 0, 1, 2, ..., n*. (Note that n* = fixed
constant at this step).
d)
select the value of T (i.e. T* ) that corresponds to the smallest C(T,n*). Thus the present
equipment should be used for T* time periods and then replaced with the technologically
improved equipment, which should itself then be replaced at intervals of n* periods of
time.

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