Equipment Replacement Policy

Equipments

-Capital Equipments (industrial, expensive)

-Light Equipment

Reasons for replacement

1. Deterioration- It becomes necessary to replace the machine when it wears

out and does not work properly. Such machine starts lowering the quality of
product, decreasing the volume of production and increasing labour and
maintenance cost.

2. Obsolete- Semi automatic is becoming obsolete now. Whenever new

equipment comes in the market which is capable of producing more products
of good quality with less labour and has more efficiency than the existing
machine needs to be replaced.

3. Inadequacy- The change of product design to meet the customer demand or

quality to be manufactured, old machinery becomes inadequate. Such
machinery needs replacement.

4. Working Conditions- Machinery yielding more smoke or noise is hazardous to

work with. It may cause pollution as well as accident. Therefore workers in
general may not like to work because of dangerous nature of particular
process. Such machinery needs replacement. Guidelines in replacement
analysis are as under:-

A. For equipment in use to consider-

-Operating Cost

-Repairs and maintenance cost

-Downtime Cost (failure of equipments or time during which production

could not be done)

-Salvage value (Scrap value)

-Rebuilding cost

Do not consider

-Original Cost

-Money already spent on repairs and maintenance.

 B. For new equipments to consider-

-Initial Cost

-Interest on capital investment.

-Salvage value at the end of useful life.

-Cost advantage of improved product.

-Labour saving.

Do not consider any overhead charges.

Replacement of item whose maintenance and repair cost increases with time
ignoring changes in the value of money during the period

Let us consider

C = Capital Cost

S = Scrap/ Salvage Value

Tav = Average annual total cost

n = No. of years the item in use

f(t) = Function time operating and maintenance cost (M) of the item at time t.
It is desired to find the value of “n” that minimizes ‘Tav’

Annual average cost = C + M - S

(Tav) n

Replacement of items whose maintenance cost increases with time and

value of money also changes in time. As the money value changes with time,
we must calculate the present worth of money to be spent in few years and
hence it is the interest rate (i) per year. A rupee invested at present will be
equivalent to 1+I after an year and hence (1+i)2 after 2 years and hence
(1+i)n in n years time.

In other words making a payment of 1 rupee after n year is equivalent to

paying (1+i)-n now. The quantity (1+i)-n is called present worth or present
value of 1 rupee spend in n years from now.

Present value of rupee spend in n year = (1+i)-n

= Vn
 V=1/ (1+i)n

It is also called discount rate and is always less than unity.

Contracts:

It is an agreement between the 2 parties. The terms and conditions in the

agreement are mutually accepted by both the parties.

Areas- The areas where contracting system can be introduced economically

are

1. Major civil, electrical and mechanical works.

2. Maintenance of the sophisticated machinery, pest control, flower

arrangements, carpet shampooing, security etc.

Advantages of contracts-

1. Reduction of total labour cost

2. Reduction of cost of supplies and equipment

3. Use of latest techniques and methods

4. Saving administrative work and time.

5. Flexibility to meet emergencies or changes in need.

6. Removal of need to negotiate with labour union.

7. Removal of need to recruit and train employees.

Disadvantages-

1. False labour cost saving unless staffing levels are actually reduced.

2. Gradual escalation in total cost with property level monitoring or controls.

3. Managerial laziness resulting in failure to negotiate the best price for the
service.

4. Unavailability of employee for the other tasks.

5. Loss of control over employees.

6. Loss of contact with the need of facility and staff.