Gains from investment timing over the business cycle: Machine replacement in the US rental industry†

We develop and empirically implement a model of optimal replacement of rental equipment and apply the model to derive detailed optimal replacement strategies for five different types of rental machinery: 1) excavators, 2) high reach forklifts, 3) skid steers, 4) scissor lifts, and 5) telescopic booms. Using data on actual replacements, revenues, maintenance costs, new machine prices and resale values, we find significant potential to improve rental company profitability by strategically timing the replacement of equipment, resulting in profit gains ranging from 1 percent to over 1700 per cent. We generally find optimal replacement strategies replacing machines sooner than what we observe in our sample. However in the case of excavators the optimal policy involves replacing machines significantly later than the mean replacement ages for the companies in our sample. We also find gains to adjusting replacement strategy to account for seasonal variation in rental demand and the timing of the business cycle due to their effects on rental revenues and the cost of replacement. For some machines, such as skid steers, we find the optimal replacement strategy is pro-cyclical. That is, a machine of a given age has a much higher probability of being replaced in a boom month than in a bust month. However for telescopic booms, we find that a countercyclical replacement strategy — one where replacements are concentrated in slow periods of the business cycle — can significantly increase firm profits.