Maintain, Refurbish, or Replace
Published on Tuesday, 10 December 2013 08:40:50 Written by Marc
In capital expenditure planning, the question about what to do with equipment that is getting older, or more precisely, closer to the end of its life, seems to always come back repeatedly. With just about every piece of equipment, the question will be asked, “Should we continue to maintain it, refurbish it, or simply replace it?”
I did some research to try and find information on the internet about how to conduct these decisions and there does not seem to be anything specific to help companies, which is interesting considering how often people in companies are faced with such decision making. Therefore, I decided to try it and see what criteria and items we should consider when faced with choices such as maintaining, refurbishing, or replacing equipment. While there are some formulas, concepts, and opinions on what a company should do with aging equipment and unfortunately, things do not seem to work the same in theory as in real life. It is not like gravity, which can be calculated with precision, and works both the same way in real life and theory. Because people do not manage everything with formulas, the reality of what is done is often different from the cold logic. An Example For example, take a piece of equipment, say a widget maker. If the cost of the equipment is $100,000 and it costs normally $10,000 to maintain it. Over the years, some parts will start to break and you will most probably find yourself replacing them here and there. The first five years you only had to do normal maintenance. Now, it is a $10,000 motor. The coming year, you are probably looking at a $12,000 mechanism and a $5,000 control system that you needed to change. While the rest of the widget maker is still good, you start to think that at the rate you are changing parts, soon you will have paid for a new widget maker in parts alone, without having a new widget maker. How long should you continue to maintain the equipment this way before you do a complete refurbish or a replacement? While each situation is different, the approach to the problem should not always be. Regardless of what the equipment is, there are basic elements that are the same:
- The equipment had an original cost and now has a residual value (even if its zero, the idea is that you can put an approximate value on the equipment)
- The equipment has maintenance costs (these are costs which regardless if your equipment was old or fairly new you would have anyway, much like oil change in a car)
- The equipment has irregular costs (parts breaking that need to be replaced, adjustment requirements that are not deemed to be standard maintenance)
- The equipment has downtime cost (how much you lose in production when the equipment goes down).
- What is the cost of new equipment?
- What are the features (including efficiency related ones) of new equipment? In this, we include the loss of opportunity in keeping our old non-efficient equipment alive.
- What is the period you want to consider (in months or years)?
- Maintain You equipment is now six years old (from the example above) and since you amortized it over five years, it is already fully amortized. Let us assume that you are now expensing all parts that you replace (in real life, you would probably amortize some major parts that extend the life of the equipment). Therefore, in year six, you spent $10,000 for parts in addition to the normal $10,000 for maintenance and in year seven, you now anticipate spending another $17,000 on parts, in addition to normal maintenance costs. For years eight to 11 your guess is that you will continue to replace about $17,000 of parts each year. Let us go to item number two and come back to the maintain scenario later.
- Refurbish We know that for the coming year, year seven, we will need to spend $17,000 for parts and probably that same amount for years eight to 11, so for five years in total (years seven to 11 included), a total of $85,000, not counting the normal maintenance of $10,000 per year. Suppose you could refurbish the equipment for $50,000 today and have equipment that would be under warrantee for one year would it make sense to refurbish it? Before we answer this, let us look at choice number three.
- Replace In this choice, we simply replace the equipment by a new one. If the new purchased equipment is as good as the original one, it should give us five years headache free so only the normal maintenance cost of $10,000 (assuming here that it is the same cost) needs to be considered. However, the cost of the new equipment is $130,000, which is more than the original $100,000 one we purchased six years ago. The good thing is that this new equipment is 10% more productive and should bring in, say, $30,000 more revenue per year.
- We do not know if the refurbish will really last five years before other parts will break.
- We do not know if we will be able to continue to purchase spare parts in the future. What if the manufacturer stops supporting this equipment and it is not possible to get new parts anymore? (That would obviously force a replacement of the equipment).
- We only can assume the linear cost of $17,000 per year if we continue to maintain the equipment, who knows if the costs will not escalate or if the equipment will not completely die on us next year.
- How much downtime will we be having in the coming years? If the equipment is crucial to the operations and keeps breaking down each month, you might want to refurbish it even if the cost today is higher than the estimated cost of continuing to maintain the equipment.
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