Construction Equipment costs

Dr.K.Ananthanarayanan
Professor
Department of Civil Engineering
IIT Madras, Chennai-600036
Construction Equipment can be
Owned
Leased
Rented
Contractor owned Equipment
Ownership costs (fixed)
Operating costs (variable)
Ownership costs

 Depreciation
 Interest charges
 Taxes
 Permits and licenses
 Storages parking facilities
 Insurance
Operating costs
 Maintenance direct costs:
Labor, parts, assemblies
 Operating expendables :
Fuel, oil, lubricants, tires, cables
 Maintenance overheads:
Buildings and yards, main.supervisors,
main.equipments & utilities
Charge rate determinations for Owned
Equipment cost variation over the life of
equipment
 Example: Assume that the original
purchase price is Rs1,00,000, salvage
value is 10% after life of 5 years and
6000 hours of use, maintenance costs
equal to 80% of original cost and all
other costs including fuel and oil amount
to 135% of purchase price after the life
of equipment.
REPLACEMENT ANALYSIS
REPLACEMENT ANALYSIS

REASONS FOR REPLACEMENT

Reduced performance
- Due to physical deterioration of parts
- Ability to perform at expected levels of reliability
- Productivity not adequate

 Results in
- increased costs of operation
- higher scrap and rework costs
- lost sales
- larger maintenance expenses
 Altered Requirements
- New requirements of accuracy, speed and other
specifications
- Often analysis between complete replacement and
enhancement through retrofitting

 Obsolescence
- Rapid changes in technology
- Accuracy and less productivity
REPLACEMENT ANALYSIS

MOST ECONOMIC INVESTMENTS

Actual useful life
The period over which the investment is actually used.
Depreciation life
The anticipated period of time the investment is expected
to be used and the investment depreciates from new cost
to salvage or resale value over this time period.
Economic life
A period of time defined as true life (period) for which the
net annual worth (cost) is a minimum.
Example :
An automobile is purchased for Rs 8,00,000. The anticipated
annual maintenance costs and salvage value are given below -:
For interest = 15% , what is the economic life ?
Year Annual EOY Salvage
Maintenance Costs
Value
1 0 6,00,000
2 1,00,000 5,00,000
3 2,00,000 4,00,000
4 3,00,000 3,00,000
5 4,00,000 2,00,000
REPLACEMENT ANALYSIS

Year Net Annual worth

1 -3,20,000
2 -3,06,000
3 -3,26,000
4 -3,52,600
5 - 3,81,600

390000

370000

350000

330000 Series1
310000 Series2

290000

270000

250000
1 2 3 4 5
Life (years)
 If at the end of every 2 years another automobile
could be purchased for the same price (Rs.
8,00,000) and if all other costs were the same, then
the lowest cost alternative is to replace with a new
automobile every two years.
 Since the costs of new replacement automobiles
usually rise over time, a new analysis has to be
done.
For re-evaluation - what value to place on
an investment that is several years old?

The only relevant value is the current market

value
All previous data is irrelevant.
Original costs, current book value etc have no
bearing on the analysis to be used for economic
life.
Basic Analysis – Compare two or more
alternatives currently own one of the assets
Defender –It’s replacement by one or more
challengers
REPLACEMENT ANALYSIS

 For comparison take the consultant’s view

point.
 We assume that we own neither asset.
 Assume that the defender is “purchased” at the
going market value .
- Estimate first cost P for defender
- Associated salvage value, economic life,
annual operating cost for the defender.
Note : May be different from original data, but
all part data irrelevant to present evaluation.
 Sunk cost = Present book value – Present realizable value
In case of incorrect estimates the – Positive Sunk Cost which cannot be
recovered.
Sunk cost – Result of bad decision in the past .
It must not be allowed to influence decisions of the present.
 Sunk Cost is charged to the account “unrecovered capital” reflected in the
income statement.

 Planning Horizon or study period

Two situations:
(1) The anticipated remaining life of the defender equals the life of the
challenger.
(2) The life of the challenger is greater than that of the defender .
REPLACEMENT ANALYSIS

 If the defender and the challenger have equal lives, any of the
evaluation methods previously discussed can be used with the most
current data.
If they have equal lives,
- length of the planning horizon must be first selected usually
coinciding with the longer live asset.
- Assumption usually made: the EUAW of the shortest lived costs can
be acquired at the same through out the planning horizon.
Implies that the service performed by the shorter lived asset can be
acquired at the same EUAW as presently computed for its expected
service life.
 In case of rapid technological change, uncertainty of the future leads
to management often imposing abbreviated planning horizons.
This forces the recovery of invested capital and the required return
over a shorter period of time than expected lives of the alternatives
 Selection of planning horizon is a difficult decision and must be based
on sound judgement and data.
REPLACEMENT ANALYSIS

Use of short horizon- Biases the decision in favor of the defender

Use of long horizon - Uncertainty of the future and its estimate.
CONVENTIONAL AND CASH FLOW APPROACH TO REPLACEMENT ANALYSIS
 Both give the same results.
 CONVENTIONAL APPROACH
- Use the defender’s current market value as the first cost of the defender.
- Use the initial cost of the replacement as the challenger’s first cost.
- Approach cumbersome when there is more than one challenger – each offering a
different
trade in value.
 CASH FLOW APPROACH
- When a challenger is selected, the defender’s market is a cash inflow to the
challenger
alternative , and if the defender is selected there is no actual outlay of cash.
- If the defender and challenger have same life value , set the defender first cost to
zero and
subtract the trade in value from the challenger’s first cost.
- This approach can only be used if both have same lives or comparisons are made
over
specified or preselected planning horizons.
REPLACEMENT ANALYSIS

 To determine the Replacement Value (R.V) of the defender

that will make its retention or replacement equally attractive
E UAW d = E UAW c
the unknown value R V is used for the defender first cost.

REPLACEMENT ANALYSIS FOR ONE ADDITIONAL

YEAR RETENTION
 When currently owned asset is close to the end of its useful life
or has deteriorated considerably
Question asked – Should it be replaced with a
challenger or retained in service for one or
more years ?

 Three Alternatives
- Select the challenger
- Retain the defender for one more year

- Retain the defender for its remaining life.

FLOWCHART – Procedure for one additional year replacement analysis

FLOWCHART
start

Compute EUAWC
for challenger

Set t=1
for the next year
Set t for next year
Compute CD(t)
Defender cost
next year yes
Compare < Retain defender Analyze another
CD(t) : EUAWC
= one additional year year

> no
Compute EUAWD
for the remaining
life of defender

Compare
EUAWD : EUAWC <
=
> Select challenger stop
Remove defender
REPLACEMENT ANALYSIS
EXAMPLE
A seven year old asset may be replaced with either of two assets. Current data for
alternative are given below. Use the Cash –Flow approach and a M.A.R.R = 18% per
year to determine the most economic approach

Possible Replacement
Current Asset Challenger 1 Challenger 2
defender
First Cost - 1,00,000 1,80,000
Defender trade in - 35,000 25,000
Annual Costs 30,000 15,000 12,000
Salvage Value 5,000 10,000 5,000
Estimated Life (years) 5 yrs 5 yrs 5 yrs
REPLACEMENT ANALYSIS

Solution

Defender : EUAW D = 30,000 – 5000 [ A/F , 18%, 5]

= Rs 29,301

Challenger 1 : EUAW C1 = ( 1,00,000 – 35000 ) [ A/F , 18%, 5] + 15000 - 10000 [ A/F , 18%, 5]

= Rs 34,388
Challenger 2 : EUAW C2 = ( 1,80,000 - 25000 ) [ A/F , 18%, 5] + 12,000 – 5,000[ A/F , 18%, 5]

= Rs 60,867
Therefore Defender should be retained.

If Conventional Approach is used – Two analysis D VS C1 & D VS C2:

D VS C1 D VS C2
EUAW D = Rs 40,493 EUAW D = Rs 37, 296
EUAW C1 = Rs 45,580 EUAW C2 = Rs 68,861