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Operations Management and Strategic Management · Economics of Maintenance and Spares Management

Maintenance Cost and Replacement Decisions

Updated 10 October 2026 · Fact-checked

A replacement decision asks when a machine should be replaced as maintenance cost rises. For each year of life, work out the average annual cost: net capital cost plus cumulative running and maintenance costs, divided by years. The year with the lowest average cost is the economic life, and that is when you replace.

Understand Maintenance Cost and Replacement Decisions

A machine does not cost only its purchase price. Over its life you pay for maintenance cost (routine servicing, repairs, spares, labour), breakdown cost (lost output, idle workers, delayed orders) and the capital that is used up as the machine ages. As a machine gets older, repairs and downtime usually rise, while its resale value falls.

This creates a trade-off. Keeping an old machine avoids the cost of buying a new one, but its running cost climbs every year. Replacing early spreads the capital cost over fewer years, so the yearly capital charge is high. You want the point where the two pressures balance.

The economic life of a machine is the number of years for which the average annual total cost is lowest. Total cost here means the capital cost less the resale (scrap) value at the end of that year, plus all running and maintenance costs up to that year.

A useful shortcut follows from this. While next year's running cost (plus any extra fall in resale value) is below the current average cost, keeping the machine pulls the average down. Once it goes above, the average starts to rise, and you should have replaced the machine.

The basic exam problems ignore the time value of money. If the question gives a discount rate, you must discount the costs. Read the question for that before you start.

Key rules to remember

Net capital cost after n years
Net capital cost = Purchase price (C) − Resale or scrap value at end of year n (Sn)
If the scrap value is the same at every age, this is a fixed amount. If resale value falls each year, it changes with n.
Total cost up to year n
Total cost(n) = (C − Sn) + Σ running and maintenance costs of years 1 to n
Use cumulative running costs. Do not use only the cost of year n.
Average annual cost
Average cost(n) = Total cost(n) ÷ n
The year with the minimum average cost is the economic life, when time value is ignored.
Replacement rule (no time value)
Replace at the end of year n if: cost of year n ≤ average cost up to year n−1, and cost of year n+1 > average cost up to year n
The cost of a year means its running cost plus any extra fall in resale value in that year. If resale value does not change, it is just the running cost. Use this as a check on your table.

How to solve Maintenance Cost and Replacement Decisions questions

Use the same table layout for any replacement question where running costs increase with age and no discount rate is given.

  1. 1Note the purchase price, the resale or scrap value at each age, and the running or maintenance cost for each year.
  2. 2Compute net capital cost for each year: purchase price less resale value at the end of that year.
  3. 3Compute cumulative running and maintenance cost year by year.
  4. 4Add the two to get total cost up to each year.
  5. 5Divide total cost by the number of years to get average annual cost.
  6. 6Pick the year with the lowest average cost. That is the economic life, and the replacement age.
  7. 7Check with the rule: the cost of the chosen year n (running cost plus any extra fall in resale value) should be at or below the average cost up to year n−1, and the cost of year n+1 should be above the average cost up to year n.
  8. 8State the conclusion in words, with the cost per year, and mention that time value was ignored.

Quickest way: Compare next year's cost with the running average

When to use it: Use when the resale value is constant or zero, so the net capital cost does not change with age, and you need the answer fast.

  1. Build only two columns: cumulative total cost and average cost.
  2. Stop as soon as the average cost rises for the first time.
  3. The year just before the rise is the economic life.
  4. Confirm by checking that the next year's running cost is higher than that minimum average.
  5. Write the answer and the minimum average cost.

Common mistakes in Maintenance Cost and Replacement Decisions

  • Picking the year with the lowest running cost as the replacement year.

    Students think only about maintenance cost and forget the capital cost spread over the years.

    Fix: Always decide on the average of total cost, never on the running cost of a single year.

  • Using the running cost of year n instead of the cumulative running cost.

    The table shows yearly figures, and it is easy to divide a single year's cost by n.

    Fix: Add a cumulative column first. Total cost always uses the sum of years 1 to n.

  • Forgetting to deduct resale value from the purchase price.

    The resale value is given in a separate column and gets ignored.

    Fix: Write net capital cost = C − Sn as its own column for every year.

  • Replacing too late or too early by one year.

    Students stop at the wrong row, or mix up the year in which the cost rises.

    Fix: Choose the year of the minimum average, then confirm that the next year's average is higher.

  • Ignoring the time value when a discount rate is given.

    The simple table method is practised so much that students apply it automatically.

    Fix: If a rate is stated, discount every cost to present value. If not, state that you ignore time value.

  • Writing only numbers and no conclusion.

    Students feel the table is the answer.

    Fix: Finish with a clear sentence giving the economic life, the average cost and the recommendation.

Worked examples

Example 1

A machine costs ₹1,00,000. Its yearly maintenance cost and year-end resale value are: Year 1: ₹10,000, ₹70,000; Year 2: ₹14,000, ₹50,000; Year 3: ₹20,000, ₹35,000; Year 4: ₹30,000, ₹25,000; Year 5: ₹42,000, ₹15,000. Ignoring time value, find the economic life of the machine.

Show the solution
  1. Net capital cost (cost − resale): Year 1 ₹30,000; Year 2 ₹50,000; Year 3 ₹65,000; Year 4 ₹75,000; Year 5 ₹85,000.
  2. Cumulative maintenance: Year 1 ₹10,000; Year 2 ₹24,000; Year 3 ₹44,000; Year 4 ₹74,000; Year 5 ₹1,16,000.
  3. Total cost: Year 1 ₹40,000; Year 2 ₹74,000; Year 3 ₹1,09,000; Year 4 ₹1,49,000; Year 5 ₹2,01,000.
  4. Average annual cost: Year 1 ₹40,000; Year 2 ₹37,000; Year 3 ₹36,333 (approx.); Year 4 ₹37,250; Year 5 ₹40,200.
  5. The minimum average is in Year 3.
  6. Check, Year 3 cost: maintenance ₹20,000 plus ₹15,000 fall in resale value (₹50,000 to ₹35,000) = ₹35,000, which is at or below the Year 2 average of ₹37,000.
  7. Check, Year 4 cost: ₹30,000 maintenance plus ₹10,000 fall in resale value (₹35,000 to ₹25,000) = ₹40,000, which is above the Year 3 average of ₹36,333. So replace at the end of Year 3.

Answer: The economic life is 3 years, with a minimum average annual cost of about ₹36,333. The machine should be replaced at the end of Year 3.

Example 2

A machine costs ₹40,000 and has a scrap value of ₹4,000 at the end of any year. Running costs for years 1 to 6 are ₹5,000, ₹7,000, ₹10,000, ₹14,000, ₹19,000 and ₹25,000. Ignoring time value, after how many years should it be replaced?

Show the solution
  1. Net capital cost is fixed: ₹40,000 − ₹4,000 = ₹36,000.
  2. Cumulative running cost: ₹5,000; ₹12,000; ₹22,000; ₹36,000; ₹55,000; ₹80,000.
  3. Total cost: ₹41,000; ₹48,000; ₹58,000; ₹72,000; ₹91,000; ₹1,16,000.
  4. Average cost: Year 1 ₹41,000; Year 2 ₹24,000; Year 3 ₹19,333 (approx.); Year 4 ₹18,000; Year 5 ₹18,200; Year 6 ₹19,333 (approx.).
  5. The lowest average is ₹18,000 in Year 4.
  6. Check, Year 4 cost: running cost ₹14,000 is at or below the Year 3 average of ₹19,333, so keeping the machine through Year 4 was right.
  7. Check, Year 5 cost: running cost ₹19,000 is above the Year 4 average of ₹18,000, so replace at the end of Year 4.

Answer: Replace the machine at the end of Year 4, when the average annual cost is at its minimum of ₹18,000.

Exam tips

  • Draw the full table every time. Step marks are given for net capital cost, cumulative cost and average cost columns.
  • Read the question for a discount rate or for a new machine to compare with. If either is given, the simple table is not enough.
  • Write the formula and the replacement rule in one line before the table. It shows the examiner your logic.
  • In MCQs, you often only need the average-cost row. Compute totals quickly and find where the average first rises.
  • Finish with a sentence stating the economic life, the minimum average cost and the recommendation.

Practice questions from Economics of Maintenance and Spares Management

Maintenance Cost and Replacement Decisions in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Maintenance Cost and Replacement Decisions: frequently asked questions

What are the main maintenance cost components?

They include routine servicing and preventive maintenance, repair and breakdown cost, spare parts and their holding cost, and maintenance labour. The cost of downtime, such as lost output and idle workers, is also counted when the question gives it.

What is the economic life of a machine?

It is the number of years for which the average annual total cost of owning and running the machine is lowest. The total includes net capital cost and all running costs up to that year.

When should I replace a machine as maintenance cost rises?

Replace at the end of the year with the lowest average annual cost. Equivalently, replace when the next year's running cost (with any extra fall in resale value) goes above that minimum average.

Do I include time value of money in replacement problems?

Only if the question gives a discount rate or asks for present values. Without a rate, the standard exam method ignores time value, and you should say so in your answer.