Replacement theory is used to decide when to replace used equipment with new, improved equipment. It considers factors like equipment deterioration over time, failures, technological advancements, and increased demand. There are several replacement models that take different factors into account, such as how equipment ages and becomes outdated, the availability of newer machines with better usage, the depreciation of equipment value over time, and replacing groups of items that fail completely after use. Replacement theory helps determine the optimal time to replace equipment to minimize costs and maximize benefits.