An overhaul–replacement model for equipment subject to technological change in an inflation-prone economy

A stochastic finite horizon model incorporating inflation and income tax effects is formulated to evaluate overhaul–replacement decisions of equipment subject to technological change. Overhaul is introduced in the formulation as an alternative policy, and the cost of overhauling is assumed to vary with the age of the equipment. The revenue and cost elements in each period are functions of both equipment age, and age at last overhaul. Time-dependent differential rates of inflation are used throughout the analysis to remove the unrealistic assumption of traditional self-cancelling approach, which proposes that all prices in the economy are influenced by the uniform periodic rate of increase. The uncertainty due to variability in the outcome of policy decisions is taken into account using discrete time Markov chains. The optimal integrated policy that maximizes the expected present worth of the process over a specified planning horizon is determined via dynamic programming. An illustrative application is provided to test the model's sensitivity to the changes in differential rates of inflation, interest rate, and tax rate estimates. The results emphasize the proper handling of inflation in determing the optimal overhaul–replacement policy.