5. Example on Estimating Ownership Cost

Now, let us move on to the next important component of the ownership cost and that is your cost of investment. So, investment cost it represents the annual cost of capital invested in the machine?

This chunk introduces the concept of the cost of investment, which refers to the annual expense associated with financing the machine. This includes costs incurred whether the machine is purchased outright or financed through loans. The investment cost is essentially the capital that has been used to acquire ownership of the machine, highlighting its importance in calculating overall ownership costs.

Think of the cost of investment like the interest you would pay on a personal loan to buy a car. Just like the car requires you to pay back the loan along with interest, the machine's investment cost requires you to account for any financing costs or missed investment gains.

So, either in this case, the interest will be the interest for the loan what you are paying in this case. The interest rate will be the rate of return you might have achieved by investing the money in something else instead of buying the equipment.

In this portion, it explains that the cost of investment can arise from two scenarios: if the machine is financed through a loan, you incur interest payments; if purchased with company assets, you forego potential investment returns. The overall investment cost accounts for both scenarios since in both cases, there is an opportunity cost associated.

If you had $10,000 and you were deciding between buying a machine or investing in stocks that could yield a 5% return, the cost of investment for the machine would include that potential loss. If you buy the equipment, you lose the chance to earn money from the stocks.

So, the cost of investment can be calculated by 2 different methods, as I told you earlier, one is a time value method other one is an average annual investment method.

This chunk introduces two methods for calculating the cost of investment. The 'time value method' emphasizes the importance of cash flow timing, converting future cash flows into present values to reflect their current worth. The 'average annual investment method' approximates costs based on the average value of the machine over its useful life.

Imagine planning for your future savings. In the time value method, waiting a year to add a dollar affects how much it’s worth in the future due to interest. The average annual method is like saving the same amount every year into a piggy bank; it gives you an average amount that reflects your savings over time.

So, basically you know that the cash flows are occurring at different time intervals in any construction form before we can see inflows and outflows will be occurring at a different period of time.

Here, the focus is on cash flow analysis over time. Essentially, cash flows—money coming in or out—do not occur at the same time, which can complicate evaluations of their overall worth. By using the time value method, we can assess all cash flows at a specific point in time, allowing for better analysis of investment costs.

Think of it as comparing two cash prizes: if you would receive $1,000 today versus$1,000 in five years. You would prefer the money today, as it has greater value now, due to the ability to invest it or earn interest.

So, in this method, you are going to calculate the thing approximately as a percentage of average annual investment over the useful life of the machine.

The average annual investment method provides a simpler estimation approach by calculating costs as percentages of the machine's average value throughout its useful life. This method helps streamline the analysis of ownership costs and ensures that costs reflect the depreciating value of the equipment over time.

It's similar to averaging your monthly expenses over a year to budget effectively. If you know you will spend a varying amount each month, averaging gives you a clearer picture of what to expect year-round.

So, let us summarize what are all the components ownership costs we have discussed so far. So, the components of the ownership costs are the depreciation, the cost of investment, insurance cost, the property taxes and the storage cost.

This summary ties together the key elements that contribute to the overall ownership costs of a machine. It includes depreciation (the reduction in value over time), cost of capital investment, insurance premiums protecting the machine's value, property taxes incurred, and costs for storing the machine when not in use.

Imagine a homeowner calculating the total cost of owning a house. Just like the house doesn’t just cost the purchase price, you have to consider home insurance, property tax, and maintenance—similarly, owning a machine incurs various ongoing costs.

So, now, we are going to estimate the ownership cost for this particular machine using AAI method.

This section discusses the practical application of ownership cost estimation using the Average Annual Investment (AAI) method. This calculation involves determining all costs and dividing them by annual usage hours to get a cost per hour for using the machine—important for project management and budgeting.

It's like renting a car; you want to know not only the base rental fee but also how much you’ll pay per hour—this total knowledge helps you budget for your trip better.

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