The Poisson process of machinery degradation: Application to valuation

S. Smolyak
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S. Smolyak: Central Economics and Mathematics Institute, Russian Academy of Sciences, Moscow, Russia

Journal of the New Economic Association, 2020, vol. 48, issue 4, 63-84

Abstract: The machinery degradation process is described by a random process in which failures occur with constant intensity, and with each failure the rate of benefits generated by the machinery item reduces by a random amount. If the machinery item begins to generate negative benefits, it is subject to decommissioning. We get explicit expressions for the average life of the machinery items and the coefficient of variation of the service life. Machine's value is determined by discounting the flow of benefits from its future use. This allows to link this value with the rate of benefits that the machinery item brings. In cases where there is no information on the amount of such benefits, appraisers rely on the machine's age. However, different machinery items of the same age may be found in a different condition and therefore are characterized by different values. We offer formulas for calculating the percent good factors reflecting the average decrease in the equipment's value with age. To take into account the effects of income tax, property tax and inflation, it suffices to adjust the discount rate in the constructed model. It has been verified that the proposed dependencies are in a fairly good agreement with market price data for two different types of construction equipment.

Keywords: machinery; market value; benefits; valuation; age; depreciation; percent good factors; degradation; failures; exponential failure distribution (search for similar items in EconPapers)
JEL-codes: C44 C52 D46 D81 M11 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:nea:journl:y:2020:i:48:p:63-84

DOI: 10.31737/2221-2264-2020-48-4-3

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