CHAPTER THREE
Equipment cost
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3.1. Equipment Access and Costs
3.1.1.Equipment Access
Equipment resources play a major role in any construction
activity and thus an access to such resources will be vital.
There are three basic ways of obtaining/ securing construction
equipment. These are:
i. Buying (Direct Ownership),
ii. Renting and
iii. Leasing.
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i. Buying (Direct Ownership)
Direct Ownership has the advantage of guarantying use and
control of equipment when ever demanded but requires
continuity of work for it to payback its cost because such
equipment are very expensive.
Beside, their maintenance services require adequate attention.
If a construction company foresees the use of construction
equipment continuously, direct ownership will bring down its
competitive cost of bidding to increase the chance of
acquiring/winning projects.
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ii. Rental Services
Rental Services are short term provisions of construction
equipment from renting organizations for the purpose at hand.
This is particularly advantageous; if the job is of short duration
and a construction company do not foresees continuity of
similar works.
Companies can also use rental services for testing and selecting
construction equipment before direct ownership.
Rental charges are higher than normal direct ownership
expenses.
Besides, there could be shortage during peak work seasons.
Responsibility for maintenance is usually indicated in the rental
contract.
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iii. Lease
Lease is a long term agreement for the use of an asset. and
may include a purchase option in which a portion of the lease
payments is credited toward the purchase price if the option is
exercised.
For rental and leasing system, there is what is called Equipment
Pool System.
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Buy: Lease:
– Advantage – Advantage
Provides guaranteed usage Softens cash flow constraints
– Disadvantage
– Disadvantage
Availability during peak period
Ties working capital on the Guarantee of usage
asset
– Advisable usage – Advisable usage
When there is a large (long When the quantity of job the
duration) amount of job that equipment is suited is small (short
the equipment is specialized to duration)
function
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3.2.2. Construction Equipment Costs
The three major issues related to equipment costs are:
The Optimum economical Life Time;
The Optimum way to secure a construction equipment, that is; the
cost of either Owning (Capital Cost) or Renting or Leasing of a
construction equipment; and
The Cost of Operation.
•These issues require several records or information with regard to
evaluation of equipments performances, establishing owning and
operating costs, and analyzing their replacements.
•Recent development of the information technology has made this task
better and several records keeping software’s are available on market.
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Generally, Equipment costs are divided into three major parts.
These are:
1.Accessing Costs (Owning, or Renting, or Leasing Costs),
2.Operating Costs, and
3.Overhead and markup Costs;
1. Accessing Costs
Ownership Costs:
Cash flows for purchase expenses salvage value (SV), Tax
savings from depreciation, major repair and Overhauls,
Insurance, Interest and Tax Costs, and Storage and
Miscellaneous expenses for construction equipments constitute the
significant components of Ownership costs.
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Ownership cost (OC = DC+IC)
OC- Ownership cost
DC- Depreciation costs
IC-Investment cost
Depreciation cost:
Why do equipments depreciate?
It represents the reduction in market value of an asset due
to Age (use), obsolescence (technological advancement or market
preference), wear, deterioration, etc leads to loss of value; Some
assets actually do appreciate with time.
The physical deterioration of the asset occurs due to wear
and tear with passage of time.
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Obsolescence occurs to due to availability of new
technology or new product in the market that is superior to
the old one and the new one replaces the old even though the
old one is still in working condition.
The tangible assets for which the depreciation analysis is
carried out are construction equipment, buildings,
electronic products, vehicles, machinery etc.
Depreciation amount for any asset is usually calculated on
yearly basis.
Depreciation is considered as expenditure in the cash flow of
the asset, although there is no physical cash outflow.
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Before discussing about different methods of depreciation, it
is necessary to know the common terms used in depreciation
analysis.
These terms are initial cost, salvage value, book value and useful
life.
Purchase expenses/ Initial cost is the total cost of acquiring
the asset.
Purchase expenses: include the price of the equipment, its
shipping or other forms of transporting services and necessary
custom taxes to own it. The amount paid by the owner for the
equipment (a fixed asset) is considered as an exchange
mechanism to own equipment's.
Salvage value:- represents estimated market value of the asset
at the end of its useful life.
It is revenue shown as cash inflow of equipments if they have
value at any time of their transfer of ownership or their disposal.
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Machines that wear out and posses few secondary uses could be
grouped as low salvage value equipments.
• On the other hand, there are equipments either gets overhauled to
keep their operating conditions or even have multiple service life
applications which could be regarded as high salvage value
equipments.
• There is a possibility also when subsequent brands with new and
technologically, economically and socially better products
succeed, then its salvage value will dramatically be reduced.
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Book value is the value of asset recorded on the accounting
books of the firm at a given time period. It is generally
calculated at the end of each year. Book value at the end of a
given year equals the initial cost less the total depreciation
amount until that year.
Useful life represents the expected number of years the
asset is useful in terms of generating revenue. The asset may
still be in working condition after the useful life but it may not
be economical. Useful life is also known as depreciable
life. The asset is depreciated over its useful life.
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Tax savings from depreciations: can only be applicable if only the
company who owns the equipment is profitable.
•There is a possibility to carry over to years where such profitability
occurs.
•Depreciation is a legitimate cost of business that recognizes the
loss in value of equipment over time. Tax saving from Depreciations
can be computed commonly used depreciation methods are
straight-line depreciation method, declining balance method,
sum-of-years-digits method and Production methods or IRS
Prescribed method.
•Using the first approaches, the three major factors used to
compute tax savings from depreciations are initial cost or basis,
service life in years and their salvage or residual values.
•Hence the amount that can be depreciated or claimed by way of tax
deduction is the difference between the initial net value of the asset
and it’s residual or salvage value.
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a. Straight-line (SL) Depreciation Method
It is the simplest method of depreciation. In this method it is
assumed that the book value of an asset will decrease by same
amount every year over the useful life till its salvage value is
reached.
It is called a linear method that allocates depreciation values of
equipments uniformly along its service years.
In other words the book value of the asset decreases at a linear
rate with time period.
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That is, Dlm = Ioc / N
BVn = Ioc – (N*Dlm)
Where; Dlm = Depreciation using Linear Method;
Ioc = Initial Owning Cost;
N =Number of Years; and
BVn = Book Value @ N years; OR
Annual Depr. = Ioc – Estimated Salvage Value
Estimated Useful Life (years)
Example 1: The total initial cost of Dozer is 500,000 birr; the
useful life is expected to be 5 years; and the estimated salvage
value at the end of this period is 150,000: find the annual depr. of
this equipment; using the straight line method?
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b. Accelerated Methods:
In these methods, large amounts of depreciations are considered
during the early years of the equipment life.
Two methods can be considered for accelerated depreciations
approaches.
These are:
i.Sum of Years Digit Methods and
ii.Declining Balance
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i. Sum-of-years-digits (SOYD) depreciation method
Sum of years digit method: is the application of depreciation base
which is held constant and the yearly rate is considered decreasing.
It is an accelerated depreciation method. In this method the annual
depreciation rate for any year is calculated by dividing the number of
years left (from the beginning of that year for which the depreciation
is calculated) in the useful life of the asset by the sum of years over
the useful life.
SOY=(N/2)*(N+1)
•D n = (Year digit)/(Sum of years' digit) × Amount to be depreciated
SOYD depreciation causes larger decreases in book value in earlier
years than in later years.
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Example
A Cat Excavator is available with a down payment of birr 900
with an estimated salvage value of birr 70 and five year of
service life.
The product of the multiplier and B-S for the year is the
depreciation charge for the year.
SOYD depreciation causes larger decreases in book value in
earlier years than in later years.
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ii. Declining Balance Method:
Declining Balance method: applies twice the rate of the Straight
Line method for depreciation when applied to new equipment with
a useful life of at least 3 years.
It is also an accelerated depreciation method.
In declining-balance method the calculated book value of the asset
at the end of useful life does not match with the salvage value. If
the book value of the asset reaches its estimated salvage value
before the end of useful life, then the asset is not depreciated
further.
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For straight line depreciation with N years, the rate of decrease each
year is 1/N.
Declining balance depreciation uses a rate of either 150% or 200% of
the straight-line rate.
Since 200% is twice the straight-line rate, it is called double declining
balance (DDB).
The DDB equation for any year is
DDB depreciation dt = (2/N) ( Book value)
Book value = Initial cost – total charges to date,
So, DDB deprec. dt = (2/N) (Initial cost – total charges to date)
It can be shown for DDB, that the depreciation schedule in year t is given
by:
• DDB depreciation in year t = αBvn-1(1- α )n-1
Where, α = (1.25 to 2)/N
For DDB α=2/N
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Example:- A Cat Excavator is available with a down payment of birr
900 with an estimated salvage value of birr 70 and five year of
service life. Calculate the annual depr. of this equipment; using the
DDB depreciation method?
If the salvage value of this example had not been 70, a modification
of DDB would be necessary.
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Exercise:- An equipment costs 10,000 birr with a salvage value of
2,000 birr. Useful life of the item in taxpayer’s hands is 5 years.
calculate, the depreciation value in the useful life this equipment
using all the three methods?
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Example
• Using double declining balance method, find
the annual depreciation and book value at the
end of each year for a track loader having an
initial cost of $50,000, a salvage value of
$5000, and an expected life of 5 years.
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• D n =2/N × Book value at beginning of year
Solution
• Using Equation 3-3:
• Annual depreciation factor = 2.00/5 = 0.40
– D1 =0.40 × 50,000= 20,000
– D2 = 0.40 × 30,000 = 12,000
– D3 = 0.40 × 18,000 = 7,200
– D4 = 0.40 × 10,800 = 4,320
– D5 = 0.40 × 6,480 = 2,592 use $1,480
*Because a depreciation of $2592 in the fifth year would reduce the book
value to less than $5000, only $1480 ($6480 - $5000) may be taken as
depreciation
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c. Production Method:
• Depreciation in this method accounts for the number of hours the
equipment was in use for a given year. Therefore, the asset’s cost
is recovered and prorated using a per‐unit of‐output basis.
• This method ensures that depreciation deduction is available when
the machine is productive and theoretically profitable or income
producing.
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D. IRS-Prescribed Methods. Since the Internal Revenue Service
tax rules change frequently. The Modified Accelerated Cost
Recovery System (MACRS) has been adopted by the Internal
Revenue Service for the depreciation of most equipment.
Most vehicles and equipment, including automobiles, trucks, and
general construction equipment, are classified as a 5 year property.
The yearly deduction for depreciation is calculated as a prescribed
percentage of initial cost for each year of tax life without
considering salvage value. Using the 200% DB method and the
half-year convention, the annual depreciation percentage are 20%,
32%, 19.2%, 11.52%, 11.52%, and 5.76% of years 1 through 6
respectively. Notice that regardless of the month purchase; only
one-half of the normal double-declining balance depreciation is
taken in the year of purchase.
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• The remaining cost basis is spread over a period extending through
the year following the recovery life. Thus, depreciation for 5-year
actually extends over a 6 year period as illustrated below.
Example
Using Modified Accelerated Cost Recovery System MACRS system
Method of depreciation, find the annual depreciation and book
value at the end of each year for a track loader having an initial cost
of 900,000 birr, a salvage value of 90,000 birr, and an expected life
of 5 years.
Solution:
D1=0.20 x 900,000=180,000
D2=0.32 x 900,000=288,000
D3=0.192 x 900,000=172,800
D4=0.1152 x 900,000=103,680
D5=0.1152 x 900,000=103,680
D6=0.0576 x 900,000=51,840 30
Depreciation
Schedule
e. Major Repairs and Overhauls:- are included under ownership
cost because they are meant for increasing the service life of
equipments.
These costs are additional to initial investment costs and shall be
considered expenses at the time of their investment to be added on
the Book values to be depreciated.
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f. Insurance and Tax costs (IT Costs):
Insurance costs represents the cost of fire, accident, and liability
insurance for the equipment .
Tax costs represents the cost of property tax and licenses for the
equipment.
g. Storage and Miscellaneous Expenses
Equipments require storage and other miscellaneous costs due to
bad weather, in between job times and their breakdown for
maintenance.
These demand storage places either through self ownership or
space rental services and other subsequent utilities together with
wages for operators or guards. These expenses are combined in an
overhead cost of projects which can be estimated as 0–5 %. This
can either be considered under owning costs or overhead and mark
up costs. 32
Operating Costs
• Operating costs are incurred only when
equipment is operated.
• Therefore, costs vary with the amount of
equipment use and job operating conditions.
• The major elements of operating cost include:
– Fuel cost.
– Service cost.
– Repair cost.
– Tire cost.
– Cost of special items.
– Operators' wages.
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Fuel cost
The hourly cost of fuel is simply fuel consumption per hour
multiplied by the cost per unit of fuel (gallon or liter). Actual
measurement of fuel consumption under similar job conditions
provides the best estimate of fuel consumption. It may estimated from
historical data or from manufacturer’s data or by the use of the table
below.
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TABLE 3-1: Fuel consumption factors (gal/hp)
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Service Cost
Service cost :- represents the cost of oil, hydraulic fluids, grease, and
filters as well as the labor required to perform maintenance service.
Equipment manufacturers publish consumption data or average cost
factors for oil, lubricants, and filters for their equipment under average
conditions.
Table 3.2. Service Cost Factors (% of hourly fuel cost)
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Repair Cost
• Repair cost represents the cost of all equipment
repair and maintenance except for tire repair and
replacement, routine service, and the replacement
of high-wear items, such as ripper teeth.
• It should be noted that repair cost usually
constitutes the largest item of operating expense
for construction equipment.
• Lifetime repair cost is usually estimated as a
percentage of the equipment's initial cost less tires
(Table 3-3).
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Repair Cost
• it is suggested that the Equation below used to
obtain a more accurate estimate of repair cost
during a particular year of equipment life.
Hourly Repair Cost = [Year digit/Sum of years'
digits] × [Lifetime repair cost/ Hours operated]
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Table 3.3 Typical lifetime repair cost (%of initial cost less tires)
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EXAMPLE
• Estimate the hourly repair cost for the first year of
operation of a crawler tractor costing $136,000
and having a 5-year life. Assume average operating
conditions and 2000 hours of operation during the
year.
Solution
• Lifetime repair cost factor = 0.90 (Table 3-
3)
• Lifetime repair cost =0.90 × $136,000 = $122,400
• Hour Repair Cost = [1/ 15] × [122,400/2000] =
$4.08 gondar university 40
Tire Cost
• Tire cost represents the cost of tire repair and
replacement.
• Table 3-4 may be used as a guide to approximate tire
life.
• Tire repair will add about 15% to tire replacement
cost.
• The Equation below may be used to estimate tire
repair and replacement cost.
Tire Cost = 1.15 × Cost of a set of tires ($)/Expected tire
life (h)
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Table 3.4. Typical tire life (hours)
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Special Items
• The cost of replacing high-wear items such as
dozer, grader, and scraper blade cutting edges
and end bits, as well as ripper tips, shanks,
and shank protectors, should be calculated as
a separate item of operating expense.
• As usual, unit cost is divided by expected life
to yield cost per hour.
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Operator
• The final item making up equipment operating
cost is the operator's wage.
• Care must be taken to include all costs, such as:
– worker's compensation insurance,
– Social Security taxes,
– overtime or premium pay, and
– benefits in the hourly wage .
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Total Owning and Operating Costs
• After owning cost and operating cost have
been calculated, these are totaled to yield
total owning and operating cost per hour of
operation.
• It does not include overhead or profit.
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EXAMPLE 3-6
• Calculate the expected hourly owning and
operating cost for the second year of operation
of the twin-engine scraper described below.
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EXAMPLE 3-6
Solution
• Owning Cost
– Depreciation cost:
– D2 = 4/15 × (152,000 - 16,000 - 12,000) = $33,067
(3-4)
– Depreciation = 33,067/2000 =$16.53/h
– Investment, tax, insurance, and storage cost:
– Cost rate =Investment + tax, insurance, and storage
= 10 + 8 = 18%
– Average Investment = (152 000 + 16 000)/2
= $84,000
– Investment, tax, Insurance, and storage = (84000 × 0.18)/2000
= $7.56/h
– Total owning cost = 16.53 + 7.56 =$24.09/h
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EXAMPLE 3-6
• Operating Cost
• Fuel cost:
– Estimated consumption = 0.035 x 465 = 16.3 gal/h
(Table 3-1)
– Fuel cost = 16.3 × 1.3 = $21.19/h
• Service cost:
– Service cost = 0.33 × 21.19 = $7.06/h (Table 3-2)
• Repair cost:
– Lifetime repair cost = 0.90 × (152,000 - 12,000) =
$126,000 (Table 3-3)
– Repair cost = 2/15 × (126000/2,000) = $8.40/h
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EXAMPLE 3-6
• Tire cost:
– Estimated tire life =3000 h (Table 3-4)
– Tire cost = 1.15× $12,000/3000 = $4.60/h
• Special item cost: None
• Operator wages =$8/h
• Total operating cost = 21.19 + 7.06 + 8.40 + 4.60 +
8 = $49.25/h
• Total 0 & 0 Cost
– Owning and operating cost = 24.09 + 73.25 = $73.34/h
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OVERHEAD COSTS
In addition to the Equipment owning and
operating costs as well as cost of operators, the
equipment owner’s overhead costs shall be
included in determining the overall equipment
hourly costs.
Overhead costs widely vary between equipment
owners depending on organizational structure,
number of staffs employed at head office and
project sites, salary and benefit scales, office
facilities and so on.
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Overhead costs are major costs to the
equipment owners and obviously need proper
survey of these costs. Overhead costs may
include, but not limited to, the following
items:
• Labor cost of marketing, finance, supply,
technical and administration teams working
both at the head office and project sites.
• Garages, workshops and warehouses
• Head office building depreciation or renting
costs
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• Cost of equipment mobilization and
demobilization
• Head office and project office running costs such
as desks, chairs, computers, telephone, fax,
internet, stationery and so on
• Cost of small vehicles and so on
Even though, the principles of estimating overhead
costs has a detail approach to estimate it, in this
particular case let’s assume the equipment owner
has an overhead cost amounting 15%(ERA
suggestion) of the sum of Equipment owning
costs, operating costs and operator’s costs.
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EXAMPLE 1 – (DOZER D8R)
• A. Hourly owning costs = 288.21 Birr
• B. Hourly operating costs = 284.15 Birr
• C. Hourly operator’s costs = 31.16 Birr
• D. Hourly overhead costs = 0.15*(A+B+C)
Hourly overhead costs = 90.53 Birr
EXAMPLE 2 – (LOADER 950G)
• A. Hourly owning costs = 237.44 Birr
• B. Hourly operating costs = 149.99 Birr
• C. Hourly operator’s cost = 37.67 Birr
• D. Hourly overhead costs = 0.15*(A+B+C)
Hourly overhead costs = 63.77 Birr
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EQUIPMENT BREAKEVEN COST
• Equipment breakeven cost is the sum of equipment
owning costs, operating costs, operator’s costs and
overhead costs. Accordingly, the hourly breakeven
costs for the equipments in example 1 and 2 are
computed as follows:
EXAMPLE 1 – (DOZER D8R)
A. Hourly owning costs = 288.21 Birr
B. Hourly operating costs = 284.15 Birr
C. Hourly operator’s costs = 31.16 Birr
D. Hourly overhead costs = 90.53 Birr
E. Hourly breakeven costs = A + B + C +D
Hourly breakeven costs = 694.05 Birr
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EXAMPLE 2 – (LOADER 950G)
A. Hourly owning costs = 237.44 Birr
B. Hourly operating costs = 149.99 Birr
C. Hourly operator’s cost = 37.67 Birr
D. Hourly overhead costs = 63.77 Birr
E. Hourly breakeven costs = A + B + C + D
Hourly breakeven costs = 488.87 Birr
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Profit
ERA manual suggests 10% of breakeven costs
EXAMPLE 1 – (DOZER D8R)
A. Hourly breakeven cost= 694.05 Birr
Hourly profit = 0.1*694.05 Birr
= 69.4 Birr
EXAMPLE 2 – (LOADER 950G)
A. Hourly breakeven cost= 488.87 Birr
Hourly profit = 0.1* 488.87 Birr
= 48.89 Birr
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Total rental cost
Total rental cost = Breakeven cost/ hr+ Profit/hr
EXAMPLE 1 – (DOZER D8R)
A. Hourly breakeven cost= 694.05 Birr
B. Hourly profit = 69.4 Birr
Hourly rental cost =A+B= 763.45 Birr/hr
EXAMPLE 2 – (LOADER 950G)
A. Hourly breakeven cost= 488.87 Birr
B. Hourly profit = 48.89 Birr
Hourly rental cost =A+B= 537.76 Birr/hr
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THANK YOU
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