A Real Options Approach for Joint Overhaul and Replacement Strategies with Price Cycles


Mr Maximiliano Cubillos (Student - Pontificia Universidad Catolica de Chile), Prof Aejandro FranciscoMac Cawley (Assistant Professor - Pontificia Universidad Catolica de Chile), Prof Rodrigo Pascual (Associate Professor - Pontificia Universidad Catolica de Chile)

Physical asset management decisions have a significant impact on the economic performance in capital-intensive industries, such as the mining industry. One of this decisions is the definition of the equipment overhaul and replacement strategies. Classical approaches define periodical interventions based on the equipment physical condition, considering factors such as availability and operation costs. These fixed models generally ignore two aspects in the decision making: first, the possibility to reevaluate the overhaul or replacement, not taking into account the flexibility in the decisions and second, the effect of uncertainty in economic factors, such as price, which also affect the maintenance decisions. The contribution of this paper is to study, using a real option approach, the effect of integrated price uncertainty and price cycles in joint overhaul and replacement strategy definition. To achieve this objective, we develop a real option model which determines the optimal intervention policies that maximize the expected profit. To solve the problem, we use a backwards recursion algorithm with a binomial lattice model. We present a numerical simulation case study for the mining industry to validate the effectiveness of the proposed methodology. Results show that the option-based decision model economically outperforms the classical fixed strategy approach and recommends a different equipment overhaul and replacement strategy.