7. References

Now, let us move on to the next important component of the ownership cost and that is your cost of investment. So, investment cost represents the annual cost of capital invested in the machine. It is similar to the cost of acquiring the ownership of the machine. You may have to purchase a machine or the equipment, either through borrowed funds or you might have purchased it with your company assets, so in both cases, you have to account for the cost of an investment.

The cost of investment is the annual expense related to acquiring a machine or equipment. This cost can arise from borrowing to buy the machine or using your company's existing assets. Essentially, regardless of how you finance the purchase, you need to recognize the importance of considering this cost when evaluating ownership expenses.

Imagine buying a car either by getting a bank loan or using your savings; in both scenarios, you incur a cost. If you take a loan, you pay interest, and if you use savings, you miss out on the potential return from investing that money elsewhere.

If you are going for borrowed funds, such as a loan, the interest rate is considered as the cost of interest. If you purchase equipment with your company assets, you still need to account for the potential returns you could have generated by investing that money in another way, which is also factored into the cost of investment.

When financing a machine, if you choose to use borrowed funds, the interest payments you make are directly considered a cost. However, if you decide to use your own funds, you must also think about the 'opportunity cost' - the potential earnings lost by not investing that money elsewhere. Both scenarios reflect the cost associated with your investment.

Think of it like deciding between taking a job that pays $50,000 a year or a different one that pays$45,000 but allows you to start your own business—which might earn you more. By choosing the lower-paying job, you're 'investing' in that path, which has its own associated costs.

Basically, investment costs are calculated as the interest rate multiplied by the value of your equipment. The cost of investment can be calculated by two different methods: the time value method and the average annual investment method.

To find the investment costs, you take the interest rate that applies to your funds and multiply it by the value of the machine. This gives you a straightforward figure representing the cost incurred due to investing in that equipment. There are two methods to calculate this cost: the time value method, which is precise, and the average annual investment method, which provides an approximate value.

This is like assessing how much interest you'll pay on a mortgage based on the loan amount (value) and the interest rate. The time value method could be compared to making sure that you account for every payment accurately over time, while the average annual method might be akin to averaging your monthly payments over the life of the loan.

The time value method is going to be a very accurate method. Cash flows occur at different time intervals, so we convert all cash flows to a particular time to make a rational analysis. This method considers the timing of cash flows, and uses appropriate compound interest factors to perform the calculations.

The time value method recognizes that money has a different value at different times due to inflation or investment growth. Thus, by converting future cash flows back to their present value, it allows for a more accurate reflection of their worth. Using compound interest factors helps in this process by taking into account how money grows over time.

Think of it like saving money in a bank; the longer you leave the money there (compounding), the more interest it earns. When evaluating costs, you want to know not just the amount but what that amount could grow into if it were invested instead.

The average annual investment method calculates costs approximately as a percentage of average annual investment over the useful life of the machine. This method accounts for depreciation, as the value of the equipment decreases over time, making calculations simpler by expressing costs as a percentage of this average value.

With this method, the investment cost is viewed as a portion of the average value of the machine throughout its useful life. As machines depreciate (lose value) over time, calculating from an average helps to smooth out the costs, making them easier to manage and understand.

It's similar to considering the average expenditure you spend on a car over its lifespan. Instead of tracking yearly fluctuations, you sum it up and divide it by the number of years to find an average annual cost.

Ownership costs comprise several components: depreciation, investment cost, insurance cost, property taxes, and storage costs. These components sum up to give the total ownership cost, expressed as a percentage of the average value of the machine.

Understanding the total ownership cost is crucial for financial planning. Each element—depreciation (value loss), investment costs (interest or opportunity cost), insurance (protection against loss), taxes (government obligations), and storage (physical space costs)—adds to the overall financial picture of owning a machine.

Consider the total expenses of owning a home: mortgage payments (investment), property taxes (government costs), homeowners insurance (protection), and maintenance costs (keeping it running smoothly). Each part contributes to the overall financial responsibility of homeownership.

--