Note On Replacement Analysis

TPD 503 PROCESSES AND PRODUTION MANAGEMENT
REPLACEMENT ANALYSIS
We are faced with decisions every day and in all spheres of life. A decision situation encountered
more often than not in business firms, government organisations as well as by individuals is
whether an existing asset should be retired from use, continued in service or replaced by a newer
asset. With stiff competition, the demand for higher quality goods and services, shorter response
times, this type of decision known as the Replacement Analysis is occurring more frequently.
This requires careful engineering economy studies to provide the necessary information needed
to make sound decisions that not only improve the operating efficiency of an organisation but its
competitive position too. While this study works on the same principles and methods of other
economic studies that involve two alternatives, specific decision situations occur in different
forms. Sometimes it may be whether to retire an asset without replacement or to retain it for back
up rather than primary use. On the other hand, the decision may be to augment the capacity or
capability of the existing asset. More often than not however, the decision is usually to whether
to replace an existing asset referred to as the defender with a new one known as the challenger.
REASONS FOR REPLACEMNT ANALYSIS
A variety of reasons which lead to the need to evaluate the replacement, retirement or
augmentation of assets is as a result of the economies of their use in an organisation. These
reasons are sometimes accompanied by unpleasant financial facts and implication. The major
reasons for carrying out replacement analysis are summarised under the following factors.
1. Physical Deterioration: This refers to changes that occur in the physical condition of the
asset. With continued use of an asset comes wear and tear which leads to reduced
efficiency in operation/use of the asset. As a result of this, the asset needs frequent
maintenance which leads to increased maintenance costs, increased energy use, more
operation time, etc.
2. Altered Requirement: When the demand for a good or service either increases or
decreases or the design of a good or service changes entirely, the economies of the asset
used in the production of the good or provision of the service will be affected.
3. Technology: When there’s a change in technology such as experienced in upgrades, there
will be need to change from the obsolete technology to the updated one.
4. Financing: this involves economic opportunity changes that are external to the physical
operation or use of assets and may involve income tax considerations. For example, the
lease of assets may become more attractive than ownership.
In replacement issues, however, factors more than one of these major four areas may be
involved. While replacement exercises are regarded with some apprehension, replacement of
assets often present economic opportunities for organisations. In replacement studies, the
following is a distinction between the various types of lives for typical assets.
1. Economic life: this is the period of time (years) of the minimum equivalent uniform
annual cost (EUAC) of owning and operating an asset. If a company has good asset
management culture in place, then the economic life will coincide to the period of time
that ranges from the date of acquisition to the date of abandonment, demotion in use or
replacement from the primary intended service.
2. Ownership life: this is the time between the date of acquisition and the date of disposal
by a specific owner. An asset may also have different categories of use by the owner
during this period. For example, a car may serve as the primary family car for several
years and then serve only for local commuting for several more years.
3. Physical life: is the period between original acquisition and final disposal of an asset
by its succession of owners.
4. Useful life: this is the period of time (years) that an asset is kept in productive service
(either primary or backup). It is an estimate of how long an asset is expected to be used
in a trade or business to produce income.

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TPD 503 PROCESSES AND PRODUTION MANAGEMENT

REASONS FOR REPLACEMNT ANALYSIS

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