Replacement Analysis of Aging Equipments

REPLACEMENT ANALYSIS OF PLANT AND MACHINERY
A THESIS
submitted by
VAIBHAV KAPOOR
in partial fulfilment of the requirements
for the award of the degree of
MASTER OF TECHNOLOGY
in
CONSTRUCTION TECHNOLOGY AND MANAGEMENT
BUILDING TECHNOLOGY AND CONSTRUCTION MANAGEMENT DIVISION
DEPARTMENT OF CIVIL ENGINEERING
INDIAN INSTITUTE OF TECHNOLOGY MADRAS
MAY 2008
i
CERTIFICATE
This is to certify that the project entitled Replacement Analysis of Plant and
Machinery being submitted by Vaibhav Kapoor to the Indian Institute of Technology
Madras, in partial fulfilment of the requirements for the award of the degree of Master of
Technology in Civil Engineering, is a record of bona fide work carried out by him. The
contents of the thesis have not been submitted and will not be submitted to any other
institute or University for the award of any degree or diploma.
GUIDE
Dr. K. Ananthanarayanan
Associate Professor,
Department of Civil Engineering
Indian Institute of Technology Madras.
HOD
Dr. K. Rajagopal
Professor & Head,
Department of Civil Engineering,
Indian Institute of Technology Madras.
Place: Chennai
Date: 1
st
May 2008
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ACKNOWLEDGEMENTS
The thesis as we see today in its present form is an outcome of persistent efforts and a
great deal of dedication and has drawn intellectual support from the various sources. It is
therefore almost impossible to express adequately the debts; I owe to many persons who
came up with ideas and implementations to make this a success.
I take this opportunity to thank Dr. K. Ananthanarayanan, Associate Professor, Dept of
Civil Engineering, for the invaluable guidance and frequent suggestions, incorporated
together with long hours of his precious time to help me during every course of my thesis.
His suggestions helped me to maintain a good quality of work. I am unable to find words
to express my heartfelt gratitude towards him.
I extend my sincere thanks to Mr. G. Balasubramanian of P&M Department, Larsen &
Toubro Ltd for giving me an opportunity to take up this project and complete it
successfully. My regular visits to him have always contributed to steer things in the right
and practical direction.
I would like to thank Mr. T. Chandrasekaran, RPLM (Bangalore), Larsen &Toubro Ltd
and his team in Bangalore, specially Mr. S. Gandhi and Mr. Jose Thomas for providing
the required data and arranging my visits to various sites in the region.
I would like to express my deep sense of gratitude to Dr. K.N. Satyanarayana, Prof and
Head of Lab, BTCM division for rendering valuable suggestions and laboratory facilities.
Last but not the least, I would like to thank all those friends who lent me a helping hand
at the hour of need.
Vaibhav Kapoor
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ABSTRACT
Keywords: Construction Equipment, Replacement Analysis, Equipment Replacement,
Equipment Economics, Equipment Cost Modelling.
Replacement analysis involves the use of mathematical models and analysis to decide
how to provide a service currently being provided by some existing asset, traditionally
called the defender. Other assets, traditionally called challengers, could replace the
defender now and improved challengers may also be available in the future. The
decisions to be made are whether to replace the defender now and, if not now then when.
In order to make these decisions, replacement analysis also examines decisions regarding
replacements at future times.
In seeking to help a decision maker, this study performs two tasks. First, it creates a
mathematical description of the equipment costs defining the economic behaviour of the
equipment; this description is called a cost model. Second, the study performs
mathematical manipulations on the model in order to extract the model's implications.
This step, which we call decision analysis or decision modelling, may include methods
such as proving implications of the model, finding the optimal solution to the model,
simulating the model on a computer, and so forth. The results obtained through this
research should assist a decision maker in making a more informed decision on
equipments replacement but by no means it can replace him/her as replacement
decisions cannot be made on economic consideration alone.
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CONTENTS
Page
CERTIFICATE i
ACKNOWLEDGEMENT ii
ABSTRACT iii
CONTENTS iv
LIST OF FIGURES vii
LIST OF TABLES ix
CHAPTER 1 INTRODUCTION
1.1 Background 1
1.2 Need For The Study 2
1.3 Objective 3
1.4 Scope 3
1.5 Methodology 4
1.6 Thesis Outline 4
CHAPTER 2 LITERATURE REVIEW
2.1 Research Done Till Now 6
2.2 Strategic Factors 8
2.3 Articles Classification 11
2.4 Remarks 11
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CHAPTER 3 COST MODELLING
3.1 Introduction 13
3.2 Description of Factors 14
3.3 Inter Relationships Between Factors 20
3.4 Cost Terms 22
3.5 Regression Modelling 24
3.5.1 Introduction 24
3.5.2 Linear Regression Modelling 26
3.5.3 General Linear Data Model 29
3.5.4 Regression Diagnostics 30
3.5.5 Data Collection And Sample Regression 32
3.6 Cost Modelling Automation Program 39
CHAPTER 4 DECISION MODELLING
4.1 Introduction 43
4.2 Simple Model 44
4.3 Alternative Model 45
4.4 Model Algorithm 49
CHAPTER 5 DESCRIPTION OF WEBSITE
5.1 The Home Page 50
5.2 Security Feature 51
5.3 Adding a New Equipment to the Database 52
5.4 Equipment Database 55
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5.5 Replacement Analysis 57
5.6 Results 58
5.7 Changing External Data 60
5.7.1 Economic Factors 61
5.7.2 Labour Factors 62
5.7.3 Energy Factors 63
CHAPTER 6 CONCLUSIONS
6.1 Summary 65
6.2 Limitations 66
6.3 Suggestions for Further Improvement 67
REFERENCES 68
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LIST OF FIGURES
Page
Figure 2.1 Typical relationships in replacement analysis models 10
Figure 2.2 Expanded model of relationships in replacement analysis 11
Figure 3.1 Inter-relationship between replacement factors 20
Figure 3.2 Typical cash flow diagram of an equipment 23
Figure 3.3 Illustration of linear regression on a data set 27
Figure 3.4 Prod. Vs Cumulative Hours for Batching Plant(BP) at RMC 2 33
Figure 3.5 Power Units Vs Cumulative Hours for BP at RMC 2 34
Figure 3.6 Maintenance Cost Vs Cumulative Hours for BP at RMC 2 35
Figure 3.7 Spares Cost VS Cumulative Hours for BP at RMC 2 36
Figure 3.8 Daily wage rate model for Bangalore Region 37
Figure 3.9 Labour Costs Vs Cumulative Hours of use for BP at RMC 2 37
Figure 3.10 Black Box Representation of Regression Procedure 38
Figure 3.11 Procedure for selecting the best fit regression model 40
Figure 3.12 Snapshot of a sample operating cost history file 41
Figure 4.1 Cash Flow Diagram (CFD) of a single replacement cycle 44
Figure 4.2 CFD for defender and challenger for two replacement cycles 46
Figure 4.3 Flow chart for replacement decision model 48
Figure 5.1 Home page of Equipment Replacement Analysis (ERA) 49
Figure 5.2 Login page of ERA web tool 50
Figure 5.3 Add New Equipment page of ERA web tool 51
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Page
Figure 5.4 New Equipment Confirmation page of ERA web tool 52
Figure 5.5 Cost History Upload page of ERA web tool 53
Figure 5.6 Cost Model Plot of ERA web tool 53
Figure 5.7 Database Page of ERA web tool 54
Figure 5.8 Database Search page of ERA web tool 55
Figure 5.9 Record Display page of ERA web tool 55
Figure 5.10 Replacement Analysis page of ERA web tool 56
Figure 5.11 Results page of ERA web tool 58
Figure 5.12 External Factors page of ERA web tool 59
Figure 5.13 Economic factors page of ERA web tool 60
Figure 5.14 Labour factors page of ERA web tool 61
Figure 5.15 Energy factors page of ERA web tool 62
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LIST OF TABLES
Page
Table 3.1 Elements of Deterioration 25
Table 3.2 Details of the RMC plants visited for data collection 32
Table 3.3 Results of production regression modelling for BP at RMC 2 33
Table 3.4 Results of energy regression modelling for BP at RMC 2 34
Table 3.5 Results of maintenance regression modelling for BP at RMC 2 35
Table 3.6 Results of spares cost regression modelling for BP at RMC 2 36
Table 4.1 Limiting values of k and l 47
1
CHAPTER 1
INTRODUCTION
1.1 BACKGROUND
Any equipment that is used in construction industry (or other) has two life periods
associated with it A physically limited working life which is fixed by the manufacturer
and a cost-limited economic life which is associated with the economic conditions in
which the equipment operates. The physical life depends on the manufacturers
competence to produce a quality product and to an extent on the working conditions of
the equipment. Thus nothing much can be done about it once the equipment is bought and
it will continue to function until its physical life is over. Economic life, on the other hand
is that milestone which may reach before the physical life of the equipment but after
which the equipment is financially unviable to run. The equipment may still be fit to
operate but it starts losing money instead of earning it. The obvious question which then
comes to the mind is when to call it a day? Most of these decisions of replacing the
current equipment with a new one, in the industry, are based on past experiences,
productivity, owning & operating costs, major repairs, availability and cost of spares,
technological obsolescence and sometimes even on emotional attachments with the
equipment!
The central concept of replacement analysis is concerned with finding the correct balance
between falling trade-in value and rising repair and maintenance costs of the equipment
so that the overall cost to the firm of owning and using the equipment is as small as it can
be. Some equipments are replaced often and with equipments of a more or less similar
kind. They are usually replaced before they are completely worthless and the problem
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continually arises of deciding just how quickly such assets should be turned over. If they
are held until practically worn out physically some costs, such as repairs, become very
high. On the other hand trade-in value falls rapidly in the early years of equipments life
and much more slowly later.
1.2 NEED FOR THE STUDY
By conducting several interviews with personnel dealing with replacement of equipments
in the Indian construction equipment industry it was found out that a rigorous economic
analysis is never carried out before taking the replacement decision. Top and middle level
managers often rely on experience and gut feeling while making the judgment. Decision
taken in such a manner may at times prove to be correct to a desired level of accuracy but
has no scientific proof supporting it. When such a process of making decision is analyzed
for a huge organisation having several people taking decisions for corresponding
equipments is adopted, it results in the process becoming a completely arbitrary one. No
single system exists with the contractors and equipment owners in the Indian construction
industry that accurately processes the range of available inputs and makes a decision
based on such an analysis. The motivation behind this research is to make this process
more accurate and consistent by taking into account all the quantitative and qualitative
parameters associated with the equipment and analyzing them before making a final
decision on replacement so that it would ensure an economically beneficial decision,
saving a lot of money to the contractor (equipment owner).
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1.3 OBJECTIVE
The objective of the project is to refine and improve the decision making process by
applying the replacement models to construction equipments.
This objective addresses the absence of a comprehensive decision making tool which
takes into account all the major factors contributing to replacement of construction
equipments. The factors are Direct Cost considerations (Acquisition, Operational &
Maintenance Costs), Obsolescence & Technological Advancements, Equipment
Productivity, Maintenance Periods, Market Forces (Tax rates & Inflation) and Working
Condition.
Thus a more precise objective is to enhance the existing process of replacing construction
equipments by incorporating all of the aforesaid factors.
In order to make the results of this research fruitful to the industry a web application will
be developed that will help taking replacement decisions.
1.4 SCOPE
Replacement analysis of equipments is a vast topic which can be broadly categorized into
two domains: Replacement based on failure of the equipment and based on economic
considerations. Replacement based on failure focuses on developing failure prediction
models that forecast the time of physical failure of the equipment based on past failure
records. This kind of replacement analysis is beyond the scope of this research which
focuses on developing a replacement decision model based on economic considerations
alone. The study aims to arrive at a replacement decision by maximizing the net profits
(or minimizing the costs) associated with the equipment.
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1.5 METHODOLOGY
The methodology adopted to accomplish the project objective is:
- Collecting maximum information and increase knowledge on various
contributing factors, mostly through journal articles
- Selecting model equipment that is important from economic point of view on
which the model has to be applied
- Strategically combining all these contributing factors to obtain an optimized
model for replacement of the selected equipment
- Validating the result by means of opinions from experts working in the field
of construction equipment.
- Refining the model if necessary and generalizing it
- Converting the mathematical models into user friendly online web-tool to
make the decision making process swift.
1.6 THESIS OUTLINE
This thesis comprises of five chapters followed by references and appendices. A brief
outline of these chapters is given below.
Chapter 2 Details of the work done in similar fields over the past years are reviewed in
this chapter.
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Chapter 3 deals with the cost modelling using regression analysis techniques. Data from
sample equipment is taken to manually model the operating cost of the equipment. An
algorithm to automate the modelling process is described.
Chapter 4 describes the decision model used to take the final decision on replacing the
equipment.
Chapter 5 covers the description of online software tool from the result of the study,
namely Online Equipment Replacement Analysis in detail.
Chapter 6 summarizes the research outcome and elaborates on limitations and
suggestions for further improvement.
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CHAPTER 2
LITERATURE REVIEW
2.1 RESEARCH DONE TILL NOW
Most of the studies of the replacement processes have been done at the Machinery and
Allied Products Institute (MAPI) and National Centre for Education and Research in
Dynamic Equipment Policy. Operations Research Society has extended application of the
theory to phenomenon not previously treated and later extended the theory itself.
Replacement processes fall into two categories depending on the life pattern of the
equipment involved; i.e., whether the equipment deteriorates or becomes obsolete (i.e.,
becomes less efficient as compared to other equipments in the market) because of
introduction of new developments, or does not deteriorate but is subjected to failure or
death.
For deteriorating items, the problem consists of balancing the cost of new equipment
against the cost of maintaining efficiency on the old and/or that due to loss of efficiency.
Although general solutions to this problem have been obtained, models have been
developed and solutions have been found for various sets of assumptions about the
conditions of the problem.
Grantt has solved the replacement problem assuming that a. there will be no new more
efficient equipment made available before replacement, b. the value of money remains
constant over the useful life of the equipment, and c. annual operating costs do not
decrease. Terborghs model assumes a constant rate of technological improvement. He
computes the past rate of obsolescence and projects it into the future. He also uses a
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predicted price of new equipment in the future but does not take into account the possible
errors in the predictions.
Dean has criticized the use of fixed discount rate (as employed by Grant) to compute the
cost of investment. He employs a method which involves a comparison of alternative
investments. Consequently, in his model investment costs change with business
conditions and opportunities.
The underlying mathematics of replacement processes has a relatively long history. The
problem has attracted the attention of various prominent mathematicians, statisticians,
economists and actuaries. Among them are Blackwell, Brown, Chung and Pollard, Chung
and Wolfowitz, Doob, Feller, Karlin and Preinreich.
Following the work of Alchian at RAND, Bellman has applied the functional equation
technique of the theory of dynamic programming to replacement problem. For a given
output of equipment and its cost of upkeep as a function of time, under the assumption
that replacement is possible only at specified times and that delivery of equipment id
immediate, Bellman has found a policy which maximizes the overall discounted return.
By 1986, Meredith was able to collect some 38 articles on the topic of Justifying New
Manufacturing Technology into one volume. Canada had compiled a bibliography of
113 articles. The diagnoses varied. Maybe it was the pay back criterion or maybe it was
unreasonably high rate of return requirements. May be we had just forgotten that man
shall not make decisions by economic analysis alone. After much debate, a few major
themes emerged as evidence by the direction of research articles since 1986. It was not
what the replacement analysis included that was the problem. It was what they didnt
include.
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One simplification of replacement models that was attacked was the single machine
performance. There was a growing recognition of the interdependencies of the separate
equipment items in a manufacturing or service industry system. Multiple machine
replacement analysis was formulated to address this concern. Another concern was that
modern technology produced some cost savings in categories of overhead and indirect
expenses that are commonly overlooked in application of replacement models. Examples
are savings resulted from reduced inventory, improved design/production interface,
simplified scheduling procedures, lower scrap rates, and reduced rework. The typical
replacement models certainly did not prevent these costs from being included, but it was
the responsibility of the analyst to determine what these cost savings would be. Models
were later developed that explicitly include some of these factors.
2.2 STRATEGIC FACTORS
Three major levels of decisions in an organization are often distinguished: strategic,
tactical, and operational. Traditionally, replacement decisions have been treated as
tactical decisions, that is, they carry out a strategic decision to provide a function for the
organization for a fairly long period of time. The replacement decision is not treated as a
strategic decision since the need for the function is not questioned, and it is not treated as
an operational decision since replacement decisions are made relatively infrequently and
affect the firm for a long period. When the challenger differs dramatically from assets
available in the past, the traditional treatment of the replacement decision as a tactical
decision is not appropriate. In these situations, the challenger is not simply another way
to provide the same function as the defender, rather, it embodies a different mix of
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functions, providing some new functions and eliminating some functions the defender did
provide. Acquiring such a challenger is a strategic replacement decision. The introduction
of computerized manufacturing systems is an example of a strategic replacement
situation that many companies face now.
Another major recognition was that changes in production technology are often strategic
moves more so than tactical moves. Rather than being driven by cost savings, they are
being driven by competitive considerations. In todays market place, being able to produce
a product faster, or with higher quality or with greater variety has a distinct advantage.
These advantages are generally not incorporated into the economic replacement models.
The dominant approach to addressing the strategic factors is to consider them as non-
economic criteria through such techniques as multi-attributive analysis or expert system
technology.
Azzone and Bertele address strategic factors from a strictly economic perspective
(although not considering deterioration and the timing of replacements). They note that
the most suitable manufacturing system for the firms strategic position is the most
profitable system. That is, if a product or a system has a competitive advantage, then it
can command either a higher price or a greater market share, meaning a larger demand.
Higher prices result in higher profits directly, but higher demand has both a direct and an
indirect effect. Directly, it results in more revenue and indirectly, it may lead to lower per
unit production cost as a result of higher equipment utilization and other economies of
scale. Since costs and revenues are cash flows, then discounted cash flow techniques can
be used to assess the strategic factors.
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Figure 2.1 shows the relationship typically modelled in replacement analysis. To
formulate a replacement decision, one would compare the profits of two or more
machines for which cash flows are estimated. Often the demand and price are treated as
given and independent of item of equipment being used. Sometimes this allows the
revenues and the profits portion of the model to be left out and selection of equipment
based on the minimum cost.
Figure 2.1 Typical relationships in replacement analysis models
In evaluating replacement decisions that involve a change in technology, the models used
should be extended to incorporate the competitive advantages of the more advanced
machines being considered. Thus a link is needed between machine characteristic and
demand and price. If the production quantity is allowed to respond to the changes in
demand, there is a link between the demand and the operating costs via utilization.
Incorporating the significance of system interdependencies, as mentioned earlier, an
expanded model of replacement relationships is shown in Figure 2.2.
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Figure 2.2 Expanded model of relationships in replacement analysis
2.3 ARTICLES CLASSIFICATION
The details of literature survey are presented below:
Articles related to Fundamental Concepts: 26
Articles related to Obsolescence: 12
Articles related to Productivity Issues: 4
Articles related to OR issues: 13
Articles related to Equipment Maintenance: 7
Articles related to Tax & Inflation: 6
Articles related to Other Categories: 29
2.4 REMARKS
The outcome of the literature survey is that there are a lot of articles addressing
contributing factors in great depths where every author has tried to expand the particular
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dimension by presenting their respective models but there are very few works which
address all these dimensions in totality. None has combined all of this existing knowledge
to make more generic models. Also none of them has tried to apply all of these factors to
Construction Equipments.
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CHAPTER 3
COST MODELLING
3.1 INTRODUCTION
Cost modelling of the equipment is perhaps the biggest gap that exists between the theory
and the practice of replacement decision. It is impossible to take any decision on
replacement unless we know the true costs associated with the equipment. Representing
all the costs of the equipment into mathematical equations is thus a very important pre-
requisite for taking the decision. How else can one expect to choose between the two
options if one does not know which one is cheaper?
Net cost of equipment can be represented by a cost model in form of the following
equation:
Net Cost = Owning Cost + Operating Cost +Maintenance Cost Revenue
In order to successfully represent all the costs of equipment into sets of mathematical
equations several brainstorming sessions were carried out to list the factors influencing
the equipment costs. These sessions included experts from the industry and academia. As
a result an exhaustive yet generalized list of factors affecting the equipment costs was
arrived at. The list is presented below:
- Direct Acquisition and Salvage Costs
- Deterioration of the equipment
- Technological Obsolescence
- Productivity
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- Utilization
- Inflation
- Tax Regime
- Maintenance
- Availability of New Equipment
- Government Policies
- Working Conditions
3.2 DESCRIPTION OF FACTORS
The factors influencing the equipment costs are described as follows:
- Direct Acquisition and Salvage Costs: These costs consist of the price at which
the equipment was purchased, its current market value, its salvage value after
scrapping the equipment. Costs such as insurance, road tax, duties and levies are
also included under this category. Several factors under this category react
differently to time. While purchase price of the equipment keeps on increasing
with time, its current market value gets decided by demand supply gap, its
deterioration, availability. Similarly, the salvage value generally has a falling
trend with time. These factors contribute directly towards the owning costs and
are easily measurable.
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- Deterioration of the equipment: Table 3.1 shows the effect of deterioration both in
absolute and relative terms.
Table 3.1: Elements of Deterioration
Deterioration
Actual (internal) Opportunity (external)
degradation
Cost
obsolescence
Market
obsolescence
Increasing
use cost
Decreasing
capacity
Decreasing
sale value
Increasing
operating cost
as compared
to newer
equipment
Decreasing
revenue potential
as compared to
newer equipment
Pure replacement: fixed output level and price
Strategic replacement: output level
and price a function of technology
As the equipments cumulative production increases, it keeps on deteriorating and
loses its productivity. Good maintenance level can slow down the rate at which this
productivity is lost but the past data of a vast majority of equipments surveyed reveals
that the decline is always positive unless a very major overhaul takes place. Even in
the case of major overhauls or increased maintenance the deterioration leads to an
increase in costs under these headings. So, no matter under which header we book the
costs, deterioration will always lead to its increase. Since measuring deterioration is a
tough task and definition of deterioration varies for different equipment under
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consideration, productivity is chosen as its indicator. Fall in productivity of the
equipment is directly proportional to the increasing deterioration and will be
modelled accordingly. Deterioration also leads to decrease in resale value of the
equipment. Another important point to be considered here is that deterioration is
equipment specific factor and is independent of the market forces.
- Technological Obsolescence: This factor has the same effect as that of the
deterioration described above apart from the fact that it is an external factor
governed by market. Also, the technological improvements get better with time
instead of worsening as with deterioration. The equipment manufacturers
continuously strive to bring in technological advanced equipments into the
market. All technological improvement may not necessarily improve the
productivity of the equipment but may decrease some overheads or maintenance.
In the short term these advanced equipments generally have a very small level
of advancement which adds to the usability of the machine but when seen in
intermediate and long terms trends, they tend to improve the productivity.
Another significant effect of technological advancement is the decrease in market
price of the current equipment. As contractors are inclined to buying the latest
equipment in the market, the demand supply dynamics in the market pushes the
price of the obsolete equipment downwards. It can also be generalized that a
newer model has a higher purchase price than its predecessor. Whether the
increased cost of purchase of the new equipment and decrease in resale value of
the present equipment is justified by the improvement in the new equipments
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productivity is debatable and one of the very important questions this research
aims to answer.
- Productivity: Equipment productivity is the most important factor which decides
its behaviour with time. All equipments lose their productivity with time and all
class of equipments gain productivity as the time passes. These two effects are
explained by the above two factors of deterioration and technological
advancements. When talking over a lifetime of single equipment the productivity
generally shows a parabolic trend where it increases first and then falls. The
increase can be attributed to the learning curve effect and getting used to
operating the equipment. The fall is due to degradation. Interestingly, productivity
is the sole measurable factor which branches out to other measurable factors
rather than converging on them. This provides a very convenient way of
modelling the equipment costs. Costs such as fuel, power, labour, etc. Have a
great correlation with productivity and thus an accurate forecast of productivity
can enable us to accurately forecast other dependent factors. There is also a word
of caution here as a poor correlation between productivity and time can give
wrong implications about the various costs that depend on the productivity of the
concerned equipment.
- Utilization: Equipment utilization is also a key factor that influences the cost of
the equipment. Utilization does not follow a trend with either time or production.
It however has some correlation with equipment maintenance. Better maintained
machines tend to have good utilization levels than ill maintained ones. Utilization
thus is generally a result of tactical decisions taken at the site. General
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intermediate trends in utilization of the equipment get reflected in its productivity
but it is difficult to model the short term or long term trends. While any attempt to
model the short term trends is thwarted by prevailing conditions and requirements
at site which may change on daily and sometimes even hourly basis. Long term
trends get disturbed by movement of equipments to various sites and locations. In
this study it was decided to take utilization into account but at fixed levels. This
can be justified as utilization is an external factor and hence will contribute
equally towards the old and newer equipments. Internal component of utilization,
dependent on the specific equipment due to varied maintenance levels will get
adjusted in productivity modelling.
- Inflation: This factor was included to make sure that the equipment economics
does not get separated from the broader business environment under which the
equipment operates. Inflation has been a key economic factor for a long time in
this county and has recently regained the limelight. The sky rocketing prices of
steel and oil have lead to an unprecedented increase of industrial good prices. This
has also affected the construction equipment industry in many ways. The direct
implication is that both purchase as well as resale prices of the construction
equipments have increased substantially in the past 5 years. Also, owing to
devastating prices of crude oil, the contractors through-out the world have started
to demand more efficient equipments from the manufacturers. This has also lead
to an increase in purchase price of the equipments due to technological
advancements. In this study, inflation is considered as an umbrella factor which
influences all other factors. It must be added here that inflation does not follow a
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generalized trend with time. The inflation modelling is thus beyond the scope of
this research. The results of such a modelling carried out by market pundits will
be used in the study.
- Tax Regime: Tax is another umbrella factor which gets decided by the external
agencies but gives some control in terms of the way the contractor calculates
equipment depreciation. The tax bracket under which the contractors company
falls is fixed by the government and all the taxes must be applied before reaching
the final profit after tax figure or PAT.
- Maintenance: As a famous saying goes A stitch in time can save nine.
Maintenance is a very essential indirect contributor to the net equipment costs. It
is generally seen that a minor increase in maintenance (preventive) spending can
substantially decrease the breakdown time of the machine and can hence increase
the revenue generation. The repair costs however follow an increasing trend with
time which is due to the degradation of the machine with time.
- Availability of New Equipment: One may decide to replace an aging equipment
with a new equipment in the market but the availability of the equipment with the
supplier and the time lag between placing the order and delivery can fiddle with
the entire decision model. This lag needs to be taken into account before making
the final decision. Also, another point to be considered is that if the lag is too long
such that the market dynamics as well as the equipments internal cost dynamics
change within the lag period, the model has to be reformulated.
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- Government Policies: Sometimes the government may impose a heavy duty on
imported construction equipments which otherwise are very lucrative to replace
with and at other times may provide incentives to import the equipments from a
friendly nation. There are other factors too which may provide a boon or a setback
for certain type of equipments. These factors generally depend on the prevailing
socioeconomic and political conditions. Such factors thus can never be modelled
in sets of mathematical equations and have to be considered differently. These
factors however get indirectly represented in the cost model.
- Working Conditions: Working environment of equipment is another indirect
factor that is difficult to measure but significantly influences the other factors. It
includes factors such as labour unions, climatic conditions, site equipment
management, geographical location, etc.
All of the above mentioned factors contribute towards one or more terms in the right
hand side of the cost equation.
3.3 INTER-RELATIONSHIPS BETWEEN FACTORS
Many of these factors are inter-related and hence modelling of one factor implicitly
models the other factors. The inter relationship of various factors is shown in figure 3.1.
Figure 3.1: Inter
The solid straight lines in figure 3.1
terms whereas the dotted curved lines represent the indirect relationship between the
factors. This research will focus on mod
cost terms. The internal behaviour and reactions of various factors on each other bear no
consequence on the final consolidated cost model. Another point in support of the above
argument is that in most of the cases we can measure only the individual cost terms
contributing to the equipment cost and not the direct factors.
It was also observed that all of the above mentioned factors cannot be represented in sets
of mathematical equations. For example it i
policies on construction equipment. Similarly, although working conditions and
availability can be modelled by compromising the generalization aspect of the research,
incorporation of these models would reduce its us
Figure 3.1: Inter-relationship between replacement factors
figure 3.1 show the direct relationship of these factors with cost
factors. This research will focus on modelling the direct implications of the factors on the
of the cases we can measure only the individual cost terms
contributing to the equipment cost and not the direct factors.
of mathematical equations. For example it is almost impossible to model government
incorporation of these models would reduce its usefulness. These three factors were thus
21
show the direct relationship of these factors with cost
elling the direct implications of the factors on the
of the cases we can measure only the individual cost terms
s almost impossible to model government
efulness. These three factors were thus
22
dropped off from the initial list. It should also be noted here that although these factors
are not considered for cost modelling their indirect effect on the model in terms of
productivity, tax regimes and technological obsolescence cannot be ignored. One has to
take care that although some of the factors may seem very easy to model but their
modelling can get very frustrating due to the lack of data.
3.4 COST TERMS
As already detailed, most of the factors described in the previous section are not directly
measurable for any given equipment but contribute to one of the terms in equation (3.1).
Figure 3.1 depicts these contributions. A better way is to arrive at the equipments cost
model by estimating these measurable terms after understanding the implications of these
factors on various costs. This would enhance the modelling process. Thus our approach
would be to model these terms on time and productivity. The terms on the right hand side
of the equation (3.1) also have contributing factors as described as follows:
- Owning Costs: This is obtained from the current-market-value of the equipment
and its salvage value. These are non-recurring costs that are beared at the
beginning and at the end of the equipment life. Costs such as insurance, road tax,
duties and levies are also included under this category.
- Operating Costs: This includes the recurring costs that occur throughout the
production life of the equipment. It typically includes labour costs, power/energy
charges, consumable costs, etc. Operating costs are very much correlated with the
equipments productivity which in turn is correlated with equipment run time.
- Maintenance Cost: Maintenance cost includes the cost of preventive maintenance
and cost of minor repairs. Major overhauls are not incorporated in this study due
to their random nature.
- Revenues: Revenue is the negative cost. It includes the revenue generated from
the equipment in a given period. Revenue is dependent on the production which in
turn is dependent on demand. For simplicity of comparison, the demand has been
taken as constant. This constant can however be varied. Revenue is calculated by
reducing the tax benefits and incorporating the depreciation benefits.
The challenge thus is to model t
model can be consolidated. This is represented by the following cash flo
shown in figure 3.2.
Figure 3.2: Typical cash flow diagram of an equipment
Maintenance Cost: Maintenance cost includes the cost of preventive maintenance
repairs. Major overhauls are not incorporated in this study due
to their random nature.
Revenues: Revenue is the negative cost. It includes the revenue generated from
dependent on demand. For simplicity of comparison, the demand has been
as constant. This constant can however be varied. Revenue is calculated by
reducing the tax benefits and incorporating the depreciation benefits.
The challenge thus is to model these terms in the cost equation so that a complete cost
model can be consolidated. This is represented by the following cash flow diagram as
Figure 3.2: Typical cash flow diagram of an equipment
23
Maintenance Cost: Maintenance cost includes the cost of preventive maintenance
repairs. Major overhauls are not incorporated in this study due
Revenues: Revenue is the negative cost. It includes the revenue generated from
dependent on demand. For simplicity of comparison, the demand has been
as constant. This constant can however be varied. Revenue is calculated by
hese terms in the cost equation so that a complete cost
w diagram as
24
As mentioned previously, in order to take a replacement analysis decision for the given
equipment we need to compare them in the same future time period. This calls for
forecasting their costs. Regression Analysis also known as regression modelling is one of
the most widely used techniques for analyzing and forecasting such data. Before fitting
the past data into sets of equations to predict the future costs, a brief insight into
regression analysis is required.
3.5 REGRESSION MODELLING
3.5.1 Introduction
Regression analysis is a technique used for the modelling and analysis of numerical data
consisting of values of a dependent variable (response variable) and of one or more
independent variables (explanatory variables). The dependent variable in the regression
equation is modelled as a function of the independent variables, corresponding
parameters ("constants"), and an error term. The error term is treated as a random
variable. It represents unexplained variation in the dependent variable. The parameters
are estimated so as to give a "best fit" of the data. Most commonly the best fit is
evaluated by using the least squares method, but other criteria have also been used.
Data modelling can be used without there being any knowledge about the underlying
processes that have generated the data; in this case the model is an empirical model.
Moreover, in modelling knowledge of the probability distribution of the errors is not
required. Regression analysis requires assumptions to be made regarding probability
distribution of the errors. Statistical tests are made on the basis of these assumptions. In
25
regression analysis the term "model" embraces both the function used to model the data
and the assumptions concerning probability distributions.
Regression can be used for prediction (including forecasting of time-series data),
inference, and hypothesis testing and modelling of causal relationships. These uses of
regression rely heavily on the underlying assumptions being satisfied. Regression
analysis has been criticized as being misused for these purposes in many cases where the
appropriate assumptions cannot be verified to hold. One factor contributing to the misuse
of regression is that it can take considerably more skill to critique a model than to fit a
model!
Underlying assumptions before performing the analysis
- The sample must be representative of the population for the inference prediction.
- The dependent variable is subject to error. This error is assumed to be a random
variable, with a mean of zero. Systematic error may be present but its treatment is
outside the scope of regression analysis.
- The independent variable is error-free. If this is not so, modelling should be done
using Errors-in-variables model techniques.
- The predictors must be linearly independent, i.e. it must not be possible to express
any predictor as a linear combination of the others.
- The errors are uncorrelated, that is, the variance-covariance matrix of the errors is
diagonal and each non-zero element is the variance of the error.
- The variance of the error is constant (homo-scedasticity). If not, weights should
be used.
26
- The errors follow a normal distribution. If not, the generalized linear model
should be used.
3.5.2 Linear Regression Modelling
In linear regression, the model specification is that the dependent variable, y
i
is a linear
combination of the parameters (but need not be linear in the independent variables). For
example, in simple linear regression there is one independent variable, x
i
, and two
parameters,
0
and
1
:
straight line:
In multiple linear regression, there are several independent variables or functions of
independent variables. For example, adding a term in x
i
2
to the preceding regression
gives:
parabola:
This is still linear regression as although the expression on the right hand side is
quadratic in the independent variable x
i
, it is linear in the parameters
0
,
1
and
2
.
In both cases,
i
is an error term and the subscript i indexes a particular observation.
Given a random sample from the population, we estimate the population parameters
and obtain the sample linear regression model:
The term e
i
is the residual,
.
27
One method of estimation is Ordinary [Least Squares]. This method obtains
parameter estimates that minimize the sum of squared residuals, SSE:
Minimization of this function results in a set of normal equations, a set of
simultaneous linear equations in the parameters, which are solved to yield the
parameter estimators, . See regression coefficients for statistical properties of
these estimators.
In the case of simple regression, the formulas for the least squares estimates are
and
where is the mean (average) of the x values and is the mean of the y values.
28
Figure 3.3: Illustration of linear regression on a data set
See linear least squares(straight line fitting) for a derivation of these formulas and a
numerical example. Under the assumption that the population error term has a
constant variance, the estimate of that variance is given by:
This is called the root mean square error (RMSE) of the regression. The standard
errors of the parameter estimates are given by
29
Under the further assumption that the population error term is normally distributed,
the researcher can use these estimated standard errors to create confidence intervals
and conduct hypothesis tests about the population parameters.
3.5.3 General Linear Data Model
In the more general multiple regression model, there are p independent variables:
The least square parameter estimates are obtained by p normal equations. The
residual can be written as
The normal equations are
In matrix notation, the normal equations are written as
y X X X ' ' =
Thus the matrix consisting of regression coefficients is given as

y X X X ' ) ' (
1
=
(3.1)
Again, SSE in matrix notation can be written as
y X y ' '

= y SSE
The regression sum of squares, SSR is
n
y
SSR
n
i
i
2
1
'
|
.
|
\
|
=

=
y X
30
Also, Total Sum off squares is
SST = SSE + SSR
or
n
y
y SST
n
i
i
2
1
'
|
.
|
\
|
=

=
y
Pearson coefficient R is given as
SST
SSR
R =
2
(3.2)
In general, R
2
always increases when a regressor is added to the model, regardless of
the value of the contribution of that variable. Therefore, it is difficult to judge whether
an increase in R
2
is really telling us anything important. Here an adjusted R
2
is used
which is independent of the number of regressor. It is given as:
1
) (
1
2
=
n
SST
p n
SSE
RAdj
(3.3)
where p is the number of regressor. For all practical purposes, the value of this
adjusted R
2
will be used in the regression modelling.
3.5.4 Regression Diagnostics
Once a regression model has been constructed, it is important to confirm the goodness
of fit of the model and the statistical significance of the estimated parameters.
Commonly used checks of goodness of fit include the R-squared, analyses of the
pattern of residuals and hypothesis testing. Statistical significance is checked by an F-
test of the overall fit, followed by t-tests of individual parameters.
31
Interpretations of these diagnostic tests rest heavily on the model assumptions.
Although examination of the residuals can be used to invalidate a model, the results
of a t-test or F-test are meaningless unless the modelling assumptions are satisfied.
- The error term may not have a normal distribution. See generalized linear model.
- The response variable may be non-continuous. For binary (zero or one) variables,
there are the probit and logit model. The multivariate probit model makes it
possible to estimate jointly the relationship between several binary dependent
variables and some independent variables. For categorical variables with more
than two values there is the multinomial logit. For ordinal variables with more
than two values, there are the ordered logit and ordered probit models. An
alternative to such procedures is linear regression based on poly-choric or poly-
serial correlations between the categorical variables. Such procedures differ in the
assumptions made about the distribution of the variables in the population. If the
variable is positive with low values and represents the repetition of the occurrence
of an event, count models like the Poisson regression or the negative binomial
model may be used
32
3.5.5 Data Collection and Sample Regression
As per the research methodology a model equipment had to be chosen for which the
above regression analysis can be done to obtain the cost model. After discussions with
industry experts a set of four Concrete Batching Plants in Bangalore were chosen. All
these plants belonged to L&T Concrete and operated for their Ready Mix Concrete
(RMC) Plants in and around the city of Bangalore. The reasons for choosing Concrete
Batching Plant in RMC industry were:
- Concrete Batching Plants are one of the most expensive piece of equipment class
in the construction industry and hence the relative benefits of forming a
replacement strategy for these equipments would be much larger than say a
welding machine
- Larsen & Toubro, one of the beneficiaries of this research has a large number of
aging Concrete Batching Plants
- RMC industry has predictable levels of demand and utilization
- Concrete Batching Plants are similar to a factory production environment and thus
has clearly defined costs and revenues
Site visits were conducted on four of these plants and all operating cost, productivity and
labour report data was collected. Unfortunately, all the data was in hard copy format and
had to be keyed in a spreadsheet program (Microsoft Excel 2007) before analysis can be
done.
33
Details of the visited plants are summarized in the table 3.2:
Table 3.2: Details of the RMC plants visited for data collection
Asset Code Model
Purchase Date
(yyyy-mm-dd)
Location
13260049 CP 30, Schwing 2000-06-01 RMC 2, Bangalore
A spreadsheet template was created in which the formulas was set to evaluate the
regression coefficients and adjusted R
2
value based on the equations described in the
previous section. Regression analysis was carried out by choosing cumulative hours of
run as regressor variable and operating costs as dependent variables. The analysis was
done without the use of matrix notation. This made the entire process very tedious and a
need for automation was realized. The model with best adjusted R
2
was chosen and
forecast data for future months was prepared. The process was repeated for all
components of operating and maintenance costs. The results of the cost modelling for
concrete batching plant in RMC 2 are presented in the charts and tables that follow. The
notation for the equation is as follows:
y: Corresponding operating cost
x: Cumulative hours of production
Figure 3.4: Production Vs Cumulative Hours for Batching Plant at RMC 2, Bangalore
Table 3.3: Result of production regression modelling
Best Fit:
Table 3.3: Result of production regression modelling for Batching Plant at RMC 2
34
for Batching Plant at RMC 2
Figure 3.5: Power Units Vs Cumulative Hours for Batching Plant at RMC 2, Bangalore
Table 3.4: Result of energy regression modelling for Batching Plant at RMC 2,
Best Fit
Bangalore
35
Figure 3.6: Maintenance
Table 3.5: Result of maintenance regression modelling for Batching Plant at RMC 2
Best Fit
Figure 3.6: Maintenance Cost Vs Cumulative Hours for Batching Plant at RMC 2,
Bangalore
36
Cost Vs Cumulative Hours for Batching Plant at RMC 2,
Figure 3.7: Spares cost VS Cumulative Hours for Batching Plant at RMC 2, Bangalore
Table 3.6: Result of spares cost regression modelling for Ba
Best Fit
3.6: Result of spares cost regression modelling for Batching Plant at RMC 2
37
tching Plant at RMC 2
In order to determine the labour cost, it is important to model the increase in daily wage
of the workers in the given area. Daily wage data for skilled labourers for
years was used to prepare the forecast model.
Figure 3.8: Daily wage rate model for Bangalore Region
The result of this model was fed to the labour cost model to accurately forecast the labour
costs.
Figure 3.9: Labour costs Vs Cumulative h
of the workers in the given area. Daily wage data for skilled labourers for
years was used to prepare the forecast model.
Figure 3.8: Daily wage rate model for Bangalore Region
Figure 3.9: Labour costs Vs Cumulative hours of use for Batching Plant at RMC 2,
Bangalore
38
of the workers in the given area. Daily wage data for skilled labourers for the past 10
ours of use for Batching Plant at RMC 2,
39
Once all the operating costs were modelled, the costs were consolidated to yield the Total
cost after any given cumulative run hours h.
3.6 Cost Modelling Automation Program
Software procedures were written in order to automate the entire process of cost
modelling. As the aim was to prepare a web based application, PHP (Hypertext
Preprocessor) language was chosen to write these procedures. A user interface was
created where in an excel file was uploaded to the web server. The interface
automatically detects the run time of the equipment, production quantity and associated
operating costs depending on the field labels. The various operating costs get regressed
against cumulative run time and production. The best fit coefficients of regression
obtained by regressing each individual operating cost against the regressors are
temporarily stored in the matrix. The number of data points is also determined
automatically and the past data is fed into the regression function. When looked as a
black box the regression procedures take the equipments historical data in form of an
excel file as input and outputs regression coefficients along with the adjusted R
2
value.
This black box representation is shown in figure 3.10 as:
Figure 3.10: Black Box Representation of Regression Procedure
40
The regressors and variables are sent to various standard regression procedures and the
model with best adjusted R
2
is chosen. The standard regression procedures to which the
input is fed are:
- Simple Linear Modelling
- Polynomial Modelling (2
nd
degree)
- Logarithmic Modelling
- Exponential Modelling
- Power Modelling
Flow chart in figure 3.11 explains the procedure for selecting the best fit out of the above
regression models. The regressors and dependent variables are sent to the entire array of
probable regression procedures namely linear, polynomial, logarithmic, exponential and
power. The regression analysis is performed in these procedures and their output is
adjusted R
2
value. Another procedure determines the maximum of the adjusted R
2
value
and records the type of regression procedure in X. The procedure X is then fed with
regressors and dependent variables to yield the best fit coefficients. These coefficients are
stored for further use in the program.
These coefficients are later used to formulate the entire cost model. A sample excel file
is uploaded on the web server and regressed against the regressor variables as shown in
figure 3.12.
41
Figure 3.11: Procedure for selecting the best fit regression model
42
Figure 3.12: Snapshot of a sample operating cost history file
43
CHAPTER 4
DECISION MODELLING
4.1 INTRODUCTION
Traditional Replacement Decision Models have focussed on deciding whether the
defending equipment needs to be replaced by the challenger in todays date or not. The
basic idea behind these models is that if they suggest keeping the defending equipment
for one more period, one should repeat the analysis in next decision period with current
data prevailing at that time. Very few models have addressed the question "If not now,
then when?" ie if outcome of a replacement decision is negative (do not replace) today
then when will it get positive (replace). Put in simple words, at what time can we replace
the equipment? The answer to this question can lay a replacement strategy for the
equipment owner. This question however is a bit hard to answer as it involves accounting
the effect of future replacement on prevailing economic environment of the equipment.
As previously mentioned, the aim of this study is to formulate a replacement policy for
the equipment giving exact time (or cumulative run hours) after which it must be replaced
with the defending equipment. We know that traditional replacement analysis techniques
cannot answer the questions raised above nor can they formulate such a policy. To make
the replacement decision more comprehensive, a better model had to be developed.
Inspiration for developing this elaborate decision model has come from works of Waddell
and Christer. The model proposed by Waddell expands on the classical replacement
theory proposed by Churchman, Ackoff and Russell in their Operations Research
publication.
44
4.2 SIMPLE MODEL
The new model adequately considers most of the owners questions about time related
costs. It assumes that the equipment is to be used for some activity that has a finite
duration and that the equipment may be replaced a number of times and then salvaged at
the end of the activity. The final duration poses no practical limitation since it can be
specified as long as we want. The only consideration in this regard is that we should
expect the same cost behaviour from the equipment as exhibited in the previous years
from which cost model is derived. We know that this will never be true and hence for
sake of practicality we will reduce the number of replacements to one. This will make the
model more practical. Furthermore, it is always the first replacement we are interested in.
However while developing the model we will not restrict ourselves to single replacement
cycle.
Let us start by developing the model from the classical cost equation:
) , , / }( ) ( ) ( { ) ( k r P A r t S dt r t f P t C
k
k
o
t
}
+ = (4.1)
Where
P = Current market price of the equipment
S(t)= Resale price after k years
f(t)= Total operating cost per unit time at age given age t
k=time after which replacement will be made
r=discount factor taking into account company MARR and inflation
) , , / ( k r P A = factor to amortize the present worth of all costs on monthly basis
Here C(t) represents the cost per unit time for single replacement cycle. The cash flow
diagram for such a replacement cycle is shown in figure 4.1.
45
Figure 4.1: Cash flow diagram of a single replacement cycle
This has to be expanded to at least another replacement cycle so that the current decision
will be influenced by the future conditions. It has been already mentioned that a third,
fourth or subsequent replacement cycle will not be considered due to rapidly changing
market dynamics and limitations imposed by extrapolation of the regression model
beyond certain limits.
4.3 ALTERNATIVE MODEL
An alternative criterion function to the classical cost function explained above is
proposed as follows:
) , , / )}( ) ( ) ( ' ( ) ( ) ( { ) (
2 1
'
l k r P A r t S dt r t f P r r t S dt r t n f P t C
l
l
o
t k k
k
o
t
+ + + + + =
} }
Where
P
1
= Current market price of the equipment
P
2
= New market price of the equipment after k years
S(t)= Resale price after k years
46
f(t)= total operating cost per unit time at age given age t (derived from the cost
model)
f(t)= Challengers total operating cost per unit time at age given age t
k=time after which first replacement will be made
l=time after which second replacement will be made
r=discount factor taking into account company MARR and inflation
(A/P,r,k+l)= factor to amortize the present worth of all costs on monthly basis
The above equation represents the total discounted cost per unit time of operating
equipment currently n months old for a further k months, replacing it, and then operating
the new equipment for a further l months before replacing again. There are, therefore,
two replacements involved over a period of (k+l), and both k and l are selected to
minimize this function. It is to be noted that the only parameter of operational interest is
k, the time to replace the current operating plant. A second cycle is introduced into the
function to represent the ongoing nature of the requirement for the plant and to influence
k accordingly. Any number of subsequent replacement cycles, m say, could have been
selected and incorporated into the criterion function. Only one has been selected since the
prevailing economic situation deems it desirable to keep the period over which economic
forecasts are required, namely (k+m.l) as short as possible. The cash flow diagram for
such a replacement cycle is shown in figure 4.2.
47
Figure 4.2: Cash Flow diagram for defender and challenger for two replacement cycles
Now the function C(t) represents the total amortized cost of two consecutive
replacement cycles. The decision model constitutes the selection of k and l for which
C(t) is minimum. This can be represented as.
Replacement Age = k,l for MIN(C(t))
That is: Replacement Age = k,l for
MIN( ) , , / )}( ) ( ) ( ' ( ) ( ) ( { ) (
2 1
'
l k r P A r t S dt r t f P r r t S dt r t n f P t C
l
l
o
t k k
k
o
t
+ + + + + =
} }
)
A trivial but unacceptable solution for this problem is k = . The above equation can be
solved with the help of differential calculus for defined function f(t) and f(t). However,
in the present scenario these functions are themselves a variable. There is no information
about the precise function characteristic which gives rise to too many permutations and
combinations.
Another method of solving the above criterion is through iterations. The function can be
iterated for all possible values of k and l, and extracting their value at which cost function
48
converges on the minimum value. In order to reduce the iteration time, a smart system
was developed where in one can specify the minimum time for which the new equipment
would be kept. This would shrink the range for variable l and reduce the total number of
iterations. The above provision is also practically justified as there is always a tendency
to keep the equipment for at least 2 or 3 years before selling it off. This method can thus
remove this warming up period from the iterations. The limiting value of k and l are
provided in the table below:
Table 4.1: Limiting values of k and l
Minimum Limit Maximum Limit
k (defenders replacement) 0 Physical Equipment Life
l (challengers replacement) Minimum age to keep Physical Equipment Life
49
4.4 MODEL ALGORITHM
The flow chart for the decision model is presented in figure 4.3.
Figure 4.3: Flow chart for replacement decision model
50
CHAPTER 5
DESCRIPTION OF WEBSITE
Based on the cost modelling and decision modelling described in the previous two
chapters, a web based online replacement analysis application was made. The purpose of
this application was to provide the user with a quick economic analysis before making the
final replacement decision. Following few pages will describe the features and functions
of the website.
5.1 THE HOME PAGE
Figure 5.1: Home Page of Equipment Replacement Analysis Web Application
51
5.2 SECURITY FEATURE
The website is completely protected against anonymous logins. Only users with pre
registered ids can enter and use the website. These ids can be registered on request of the
users. It is planned to transfer the control for handling the ids to P&M department in the
headquarters. The reasons for creating authenticated logins are:
- Various users will be able to track the equipments under their command
- Users will be able to share the cost models of various equipments
- Automatic generation and expansion of the equipment database.
- Security
Figure 5.2: Login Page of Equipment Replacement Analysis Web Application
52
5.3 ADDING A NEW EQUIPMENT TO THE DATABASE
A user-friendly interface has been created to quickly add new equipments to the database.
Only the data relevant from replacement point of view is collected. User will have to
enter the unique asset code of the equipment followed by its model description. If the
equipment model is not available in the given list it can be swiftly added by clicking the
Not Available? link on the page. Rest of the data entry is self explanatory in nature.
Figure 5.3: Add New Equipment Page of Equipment Replacement Analysis Web
Application
53
It has to be noted here that Current price and Scrap price can be rough estimates of prices
at which current equipment will be sold in the market today and after its physical life
respectively.
Once the new equipment has been added, one can choose to upload the operating cost
data in form of an excel file. This upload has been previously explained in section 3.xx.
Alternatively the user can choose to skip this step. Note that cost data has to be made
available before a user can perform replacement analysis of given equipment.
Figure 5.4: New Equipment Confirmation Page of Equipment Replacement Analysis
Web Application
The cost data can be loaded by simply clicking the browse button and pointing towards
the file containing the operating cost history.
54
Figure 5.5: Cost History Upload Page of Equipment Replacement Analysis Web
Application
As soon as operating cost history is uploaded, the system plots the best-fit trends to let
the user know of the fall/rise in various parameters with respect to cumulative hours of
use. This plot is for informative purpose only but a user can detect if the trends are
grossly deviated from those expected.
Figure 5.6: Cost Model Plot of Equipment Replacement Analysis Web
Application
55
5.4 EQUIPMENT DATABASE
An equipment database is created in which equipments of various manufacturers and
suppliers can be added. The expansion of the database is kept in mind and therefore an
exhaustive search is provided to find the desired equipment for the analysis. Equipment
can be found either by entering its unique asset code or by specifying its Category,
Supplier, Model Number or state in which it is operating. This would help not only to
find the equipment of interest but would also show other similar equipments which can
be used as challengers.
Figure 5.7: Database Page of Equipment Replacement Analysis Web Application
56
As shown in the figure, when a search on all batching plants available in state of
Karnataka was performed the search resulted in listing three plants. Each of these plants
(assets) can be clicked to get their complete information. The following snapshots depict
the same.
Figure 5.8: Database Search Page of Equipment Replacement Analysis Web Application
Figure 5.9: Record Display Page of Equipment Replacement Analysis Web Application
57
5.5 REPLACEMENT ANALYSIS
The web page performing the actual analysis can be accessed from two different ways.
One can either click on Replace this equipment while searching a given equipment or
he/she can directly click the Replace link on the website. While the defending
equipment gets automatically selected in the former case, it has to be explicitly chosen in
the later.
The website has been made user friendly and a lot of smart functions are added in it. One
of those is that as soon as defending equipment is selected, the options available as
challenger automatically gets modified in the Available Challenger dropdown box
menu.
Figure 5.10: Replacement Analysis Page of Equipment Replacement Analysis Web
Application
58
Here one can choose to either replace the current defending equipment with same new
equipment or to replace it with other new equipment in the class. One can also choose the
expected level of production load in the near future. The system gives three options: low,
average and high having average as the default value. When a lower or higher value is
selected, the models are adjusted accordingly. This eradicates the need for modelling the
production demand as demand is an external factor completely independent of equipment
economics. Thus it will remain the same for an old or a new equipment.
The minimum number of years that the new equipment after replacement would be kept
can also be chosen on this page. As already mentioned this not only reduces the
computation time by reducing the number of iterations but also take care of the warm up
period of the equipment when its operating costs are generally high due to learning curve
effect.
5.5 RESULTS
After clicking the Analyze button on the web page, all the iterations described in the
previous chapter are performed. The relative amortized cost of owning and operating the
defending equipment with respect to challenger are calculated for each month beginning
from today and these costs are plotted as shown in the next snapshot. The algorithm
suggests replacing the equipment after the period when this relative amortized cost is a
minimum. The plot is an interactive one and the cost of replacing the equipment after nth
month is shown on moving the mouse cursor over the replacement line. The results page
also shows the number of iterations used to arrive at the result. This gives the fare idea on
time taken to carry out the analyses which can vary from 2 to 10 seconds.
59
Figure 5.11: Results Page of Equipment Replacement Analysis Web Application
60
5.7 CHANGING EXTERNAL DATA
One can easily change the external factors which influence the replacement decision.
These factors are categorized as:
- Economic Factors
- Labour Factors
- Power/ Energy Factors
Figure 5.12: External Factors Page of Equipment Replacement Analysis Web Application
Only administrator-users have the privileges to enter this area and make the changes.
These factors work as a constant for all analysis purpose irrespective of class or location
of the equipment. If a user desires any change in these factors he/she can issue a request
to the administrator-users. It is to be noted here that by administrator-users we mean all
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those users who are given this privilege. Each of these factors has been briefly described
below:
5.7.1 Economic Factors
It provides to alter the Company MARR (minimum attractive rate of return) or more
specifically MARR for the Plant & Machinery business unit of Larsen & Toubro, the
corporate tax rate (flat rate) under which the company comes and the prevailing inflation
rate in the economy. Due to ongoing dynamics in the Indian economy the inflation rate is
touching close to MARR for most of the construction and equipment operation
companies, making the role of inflation in the current research more relevant practically.
Figure 5.13: Economic factors Page of Equipment Replacement Analysis Web
Application
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5.7.2 Labour Factors
Labour Factor sheet allows the administrator-users to create a wage rate model for skilled
and semi-skilled labourers in a given state. One can enter the average annual wage rates
of skilled and semi-skilled labourers separated by a comma and starting from base year to
the current year. On updating this record a unique model for the state is generated and
stored in the database. Please note that a minimum of past five years data is required to
create a state specific wage model rate. In absence of a state wage model, the daily wage
model is derived from the Nation average of daily wage rates taking 2000 as the base
year.
Figure 5.14: Labour factors Page of Equipment Replacement Analysis Web Application
63
The daily wage model is needed in accurately modelling the labour costs associated with
the equipment. If a labour cost is included in the uploaded excel file at the time of model
creation, it will supersede the labour model created from daily wage rate models.
5.7.3 Energy Factors
Similar to the Labour Factor sheet, the Energy factor sheet allows the administrator-users
to create a energy rate model for kWh and kVA rates in a given state. One can enter the
average annual rates for kWh and kVA separated by a comma and starting from base year
to the current year. On updating this record a unique model for the state is generated and
stored in the database. Please note that a minimum of past five years data is required to
create a state specific energy rate model. In absence of a state energy model, the energy
model is derived from the Nation average of energy rates taking 2000 as the base year.
Figure 5.15: Energy factors Page of Equipment Replacement Analysis Web Application
64
The energy model is needed in accurately modelling the power costs associated with the
equipment. If a direct power cost instead of power unit consumption is included in the
uploaded excel file at the time of model creation, the model would be superseded.
65
CHAPTER 6
CONCLUSIONS
6.1 SUMMARY
As a part of developing replacement analysis strategy a framework for creating definite
cost models for diverse construction equipments has been developed. This framework can
help in creating specific cost models for any capital equipment. In order to validate the
framework, operating costs models for concrete batching plants are developed with the
framework to determine their optimal replacement age. As an alternative to the standard
net present value (NPV) criterion for selecting the replacement periods for capital
equipments, a criterion function is developed which relates the amortized discounted cost
over multiple replacement cycles. In view of the current market dynamics, the
replacement cycles were limited to two.
The proposed procedure can assist with the short term decision problem of when to
replace the current operating plant or equipment of a given age. Input to the model
consists of a forecast of the discount factor over fairly near future and an estimate of
operating costs based upon historic data. The estimate is obtained from a rigorous
regression analysis performed on the historic operating cost data. Operating costs relate
specifically to the replacement problem in that only those thought likely to influence the
replacement decision are incorporated. Factors such as tax allowances, regional
developments and technological improvements are readily encompassed within the
proposed model. The resulting web application for carrying out replacement analysis on
aging equipment automates the tedious process full of complex mathematical operations.
On top of that it makes the decision making process a collaborative one allowing the
66
users to share the specific equipment models with each other thereby further improving
the decision.
6.2 LIMITATIONS
Several limitations were encountered before the start of the research, during its course
and after its completion. Although most of them were taken care of as the research
progressed, those remaining are listed below:
1. This research focuses only on the economic aspect of replacement analysis. It
professes that an equipment should be replaced when it becomes economically
unviable to run. Other intangible factors which may influence the replacement
decision have been neglected by this study.
2. The cost model is completely dependent on the historic data and future
predictions are made by extrapolating the current model. This approach assumes a
constant uncertainty which is same as that existing in the available historic data.
3. The accuracy of the cost model formulated by historic data is as good as the
accuracy of the data provided. Feeding erroneous data to the system can lead to
unexpected trends.
4. Although some of the factors (section 3.2) play a very important role in taking a
replacement decision, they could not be included due to sheer uncertainty and
complexity surrounding them.
67
6.3 SUGGESTIONS FOR FURTHER IMPROVEMENT
In order to overcome the remaining limitations, following points of suggestions are listed.
These have to be dealt with at research as well as at implementation levels:
1. Research in the area of modelling the intangible factors that influence the
replacement decision would enhance the cost model. The factors such as
availability of new equipment, government policies and improving chances of
bagging a contract by using newer equipments can be given a cost implication.
2. A better modelling of prevailing and expected market conditions like price
inflations, rise/fall in scrap value, major technological advancements, etc can
provide an uncertainty model which would eventually overcome the limitation of
constant uncertainty. This can be achieved by an exhaustive market research in
construction equipments.
3. On the implementation front, the data collection process has to be fully automated
to eradicate any human intervention or manipulation. Also, the data collection
should be synchronized with the live data obtained from various equipments.
4. The number of prospective replacement cycles can be increased in future as
against two replacement cycles used in this study. This would ask for overcoming
the existing constraints both in software as well as in hardware resources.
68
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REPLACEMENT ANALYSIS OF PLANT AND MACHINERY

Thus the matrix consisting of regression coefficients is given as

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