ADDIS ABABA SCIENCE AND TECHNOLOGY UNIVERSITY
COLLEGE OF ARCHITECTURE AND CIVIL ENGINEERING
DEPARTMENT OF CIVIL ENGINEERING
CONSTRUCTION EQUIPMENT (CENG-5201)
CHAPTER SIX
EQUIPMENT LIFE AND REPLACEMENT ANALYSIS
BY FREHAILEAB A
MAY 2020
6.1 Introduction
Once a piece of equipment is purchased and used, it eventually
begins to wear out and suffers mechanical problems.
At some point, it reaches the end of its useful life and must be
replaced.
Thus, a major element of profitable equipment fleet management is
the process of making the equipment replacement decision.
This decision essentially involves determining when it is no longer
economically feasible to repair a broken piece of machinery.
Cont…
Thus, this chapter presents the three components of the economics of
equipment management decision making:
Equipment life: Determining the economic useful life for a given piece of
equipment
Replacement analysis: Analytical tools to compare alternatives to replace
a piece of equipment that has reached the end of its useful life
Replacement equipment selection: Methods to make a logical decision as
to which alternative furnishes the most promising solution to the equipment
replacement decision.
Construction equipment life can
be defined in three ways: physical
life, profit life, and economic life.
6.2 Equipment life
6.2 Equipment life (Cont…)
One can see in the graph that over the physical life of the
machine, it takes sometime for the new machine to earn enough
to cover the capital cost of its procurement.
It then moves into a phase where the equipment earns more
than it costs to own, operate, and maintain, and finishes its life
at a stage when the costs of its maintenance are greater than
what it earns during the periods when it is in operation.
6.2.1 Physical life
Physical life is the age at
which the machine is worn
out and can no longer
reliably produce.
At this point, it will usually
be abandoned or
scrapped. As construction
equipment ages,
maintenance and
operating costs increase.
6.2.1 Profit life
Profit life is the life over which the
equipment can earn a profit. The
retention beyond that point will
create an operating loss.
Thus, the equipment manager must
be able to identify when a
particular machine is nearing or
has reached this point and plan to
replace it with a new machine
while the major components are
still functional.
6.2.1 Economic life
Economic life equates to the time period
that maximizes profits over the equipment’s
life.
Equipment owners constantly strive to
maximize production while minimizing the
cost of production.
Thus, selecting economic life span as the
metric to make the equipment replacement
decision is in fact optimizing production
with respect to profit.
6.4 Replacement Analysis
Replacement analysis is a tool with which equipment owners time the
equipment replacement decision.
Through this analysis, the cost of owning the present equipment is
compared with the cost of owning potential alternatives for
replacing it.
The following sections explain both theoretical and practical methods
to accomplish this important equipment management task.
6.4.1Theoretical Method
Douglas’ theoretical methods for performing replacement analysis
include the intuitive method, the minimum cost method, maximum
profit method, and the mathematical modeling method
The value in these different approaches lies in the fact that each
method can be applied to a different type of equipment owner.
The intuitive method acts as a baseline against which other methods
can be compared. It is simply the application of common sense to
decision making
6.4.1Theoretical Method (Cont…)
The minimum cost method fits very nicely into a public construction
agency’s equipment management policy as the focus on replacing
equipment at a point in time where the overall cost of operating and
maintaining a given piece of equipment is minimized and hence the
strain on the taxpayer is also reduced
The maximum profit method furnishes a model for construction
contractors and other entities that utilize their equipment in a profit-
making enterprise to make the replacement decision with an eye on
their bottom line.
6.4.1Theoretical Method (Cont…)
Finally, the mathematical modeling method fulfills a need for a
rigorous analytical approach to this decision for those who will
eventually utilize computer-based simulations to assist in optimizing
equipment fleet size and composition for large equipment-intensive
projects
Example 6.1
An aggregate producing company presently owns a fleet of 7.5 cubic yard on
highway dump trucks that cost $65,000 each. These trucks are currently 1-
year-old and the annual maintenance and operating cost is $30,000 per truck
for the first year and increases by $2000 each year. The revenue of each truck
is $70,000 for the first year and decreases by about $1750 per year
thereafter. The owner of the company visits a national equipment show and
after talking to one of the salespersons at the show comes back and asks his
equipment fleet manager to take a look at replacing the current dump trucks
with a new model that employs a new technology, which will reduce
maintenance expenditure. The new proposed replacement trucks are of the
same size and cost $70,000 each. The annual maintenance and operating cost
is $30,000 per truck for the first year but only increases by $1500 per year
thereafter. The revenue of each truck is the same as for current model truck.
This company uses the double declining balance method for calculating
depreciation. The trucks currently in use will be called as the ‘‘current trucks’’
and the new model trucks will be called as the ‘‘proposed truck’’ in the tabular
examples that follow.
6.4.1.1 Intuitive Method
Intuitive method is perhaps the most prevalent one for making
replacement decisions due to its simplicity and reliance on individual
judgment. This method mainly depends on professional judgment or an
apparent feeling of correctness to make replacement decisions.
Equipment is often replaced when it requires a major overhaul or at
times at the beginning of a new equipment-intensive job. In addition to
these situations, availability of capital is often a decisive factor
because no reserve has been built up in anticipation of replacement.
However, none of these judgmental decisions has a sound economic
basis to be used as a criterion for an orderly, planned replacement
program.
6.4.1.2 Minimum Cost Method
Minimizing equipment costs is always an important goal for
equipment owners. However, it is paramount to public agencies that
own large and small fleets of construction equipment, as they have
no mechanism to generate revenue to offset their costs. To achieve this
goal, the minimum cost method focuses on minimizing equipment costs
based on not only cost to operate and maintain (O&M costs) a piece
of equipment but also the decline in its book value due to
depreciation.
Solution with minimum cost method
Solution with minimum cost method (Cont…)
Solution with minimum cost method (Cont…)
In Douglas’ minimum cost method, the decision to replace equipment
is made when the estimated annual cost of the current machine for the
next year exceeds the minimum average annual cumulative cost of the
replacement.
In this example, the current truck’s estimated annual cost for next year
(i.e., end of Year 2) is $47,600 and the minimum average annual
cumulative cost of the proposed truck is $43,853. Thus, if the
objective is to minimize costs, this analysis leads to a decision to
replace the current-year old trucks with the newer model.
6.4.1.3 Maximum Profit Method
This method is based on maximizing equipment profit. The method should
be used by the organizations that are able to generate revenue and
hence profits from their equipment. It works very well if the profits
associated with a given piece of equipment can be isolated and clearly
defined. However, it is not often easy to separate annual equipment
profit from entire project or equipment fleet profit. When it proves
impossible, the minimum cost method should be used to make the
replacement decision. The example used in the previous section will be
continued in the following tables.
Solution with maximum profit method (Cont…)
Solution with maximum profit method (Cont…)
Solution with maximum profit method (Cont…)
The next issue in this method is to identify the proper timing of
the replacement. This occurs when the estimated annual profits
of the current equipment for the next year falls below the
average annual cumulative profit of the proposed
replacement. In this example, the current trucks’ estimated
annual profits never exceed $24,486, which is the average
annual profit of the proposed model so that they should be
replaced immediately.
6.4.2 Practical Methods
Public and private equipment owners have developed their
own policies for making equipment management decisions.
They are typically based on empirical data as well as past
experience.
You can learn a lot by studying these methods and can
develop an understanding of what is behind each of the
systems. These methods represent a wealth of knowledge built
from decades of equipment management experience.
Thank you
