After reading this article you will learn about:- 1. Introduction to Equipment Replacement Analysis 2. Reasons for Replacement of Equipment 3. Policy 4. Guidelines 5. Hire-Purchasing.
Introduction to Equipment Replacement Analysis:
Equipment replacement decision plays an important role in the economic running of any concern for years or decades.
A firm has to face three types of replacement decisions:
(a) The replacement of capital equipment, as it wears out or becomes obsolete.
(b) The capital equipment required for expansion.
(c) The displacement of old technology by the new, i.e. the introduction of an improved equipment in the market which may produce cheaper products. It is also known as replacement of obsolete equipments.
Equipments are used to produce products at profitable rate, so that the products can stand competition. Replacement decision is not an easy job, it requires several considerations. As it involves large capital investment, hence a wrong decision may adversely effect the profitability of whole concern. Therefore, a scientific approach to solve such problems is essential.
Reasons for Replacement of Equipment:
The main reasons are:
(a) Deterioration,
(b) Obsolescence,
(c) Inadequacy, and
(d) Working conditions.
(а) Deterioration:
It becomes necessary to replace the machine when it wears out and does not function properly. Such machinery start lowering the quality of product, decreasing the production and increase in labour and maintenance costs.
(b) Obsolescence:
Whenever new equipment comes in the market, which is capable of producing more products of good quality with less labour and has more efficiency, the existing machine is to be replaced with this machine, although it was functioning well.
Generally this is necessitated because the products manufactured by new machine will be cheaper.
(c) Inadequacy:
With the change of product design to meet the customers demand or quantity to be manufactured, old machinery becomes inadequate and, therefore, calls for different manufacturing equipment.
(d) Working Conditions:
To take replacement decision, working conditions are also responsible. Machinery yielding more smoke or noise (unpleasant conditions) and hazardous to work may cause pollution and accidents. Similarly, worker may not like to work on an old machinery because of hazardous nature of a particular process. Such machinery needs replacement.
Equipment Replacement Policy:
Sometimes a manufacturer has to face a problem of replacing the equipment, since this is a continuous process and, therefore, a set system for this must be evolved. The main consideration is “when to replace” but this when requires many considerations to reach at suitable conclusion.
Large number of factors are responsible to replace the equipment before the expiry of the estimated life, some of them are:
(i) To reduce production cost,
(ii) To reduce fatigue,
(iii) To raise quality,
(iv) To increase output, and
(v) To secure greater convenience, safety and reliability.
Guidelines for Replacement Analysis:
There are certain rules which may be used as guidelines for replacement analysis:
1. For Equipment in Use:
(a) Do Consider:
(i) Operating cost.
(ii) Repair and maintenance cost.
(iii) Down time cost.
(iv) Salvage value.
(v) Rebuilding cost.
(b) Do not Consider:
(i) Original cost.
(ii) Money already spent on repairs and maintenance.
(iii) Unrealistic book value.
2. For New Equipment:
(a) Do Consider:
(i) Initial cost.
(ii) Interest on capital investment.
(iii) Salvage value at the end of useful life.
(iv) Cost advantage of improved product.
(v) Labour savings.
(b) Do not Consider:
(i) Any savings not clearly assessable.
(ii) Overhead charges.
Capital Recovery:
Capita) recovery of an equipment is the paying for itself.
“Capital recovery period”, is the time for the “pay off” period during which time any investment in the new equipment must “pay for itself”.
In replacement studies, the matter of equivalence should be considered. Because of the “interest”, a rupee today is not a rupee next year. Hence, Rupees must be converted into their value at particular time before they are truly comparable.
Hire-Purchasing:
Machines can be procured either by purchasing (i.e. paying full cost in cash) or on hire- purchase basis. In this second method (i.e. hire-purchasing) rental payments are adjusted towards the purchased price. In this way purchaser does not loose the money he has paid out in rent.
This system is now-a-days being preferred by small entrepreneur, who wants to start a small scale industry and do not have much money. Example of such system is that National Industries Corporation supplying machinery on hire-purchase basis to Small Scale Industries. Although some interest is charged on this.
Advantages:
Following are some of the important advantages of the hire- purchase system:
1. Small entrepreneur can expand his production facilities without increasing his financial burden.
2. Purchaser can use the equipment without paying the full purchase price at the time of procurement, thereby avoiding any loans or other debt.
3. This system allows the owner to use his funds for other important works like research, design, inventory, better wages etc.
Disadvantages:
Following are some of the disadvantages of hire-purchase system:
1. Some owners feel prestige in owning their machinery and they directly purchase the machines. Thus psychological aspect is a disadvantage.
2. Generally the firms charge high amount of interest (or profit) on the machines sold on hire-purchase system. Thus purchaser has to pay more price in this system.
3. Highly technical and specialised equipment’s are generally not available on hire-purchase system.