This might easy for some of you, but I am missing the functionality to replace a physical product connected to a PPR with a new revision of the physical product.

I cannot find any functionality similiar to "replace with latest revision". I guess the physical product revision is connected both to the PPR object but also with a "scope link" to the manufacturing assembly.

Where can I make the system use the newer revision of the Physical product

In the figure below you can see that MDLL00 and MDLL01 exist in a newer revision (B.1)