6. Summary of Ownership Cost Estimation

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?

Investment cost is the annual cost that reflects the capital put into acquiring equipment. This could be through borrowing funds or using company assets. In both scenarios, the cost of the investment must be accounted for to gauge the overall ownership costs incurred from utilizing machinery.

Think of it like taking out a loan to buy a car or purchasing it outright. In both cases, you would consider how much you are spending annually to finance that car (the loan interest) or the opportunity cost of using your savings instead of investing them elsewhere.

So, in both cases, whether you are going for borrowed funds or your purchase from your own companies, it is in both cases, you have to take the cost of investment.

If a company finances equipment through a loan, the interest paid on that loan is considered part of the investment costs. Conversely, if purchased outright from company funds, the potential returns that could have been earned if that money were invested elsewhere is considered as the cost of investment. Both methods effectively quantify the annual costs related to the capital used to acquire the machine.

Imagine you have $10,000. If you buy a machine with it, you lose out on the potential returns you could have made by investing that money. Alternatively, if you borrow that$10,000 at an interest rate, the cost of that interest is a direct expense from using the loan to buy the machine.

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.

The cost of investment can be assessed through two primary methods: the time value method and the average annual investment method. The time value method emphasizes the importance of the timing of cash flows, accounting for when cash inflows and outflows occur. Meanwhile, the average annual investment method simplifies calculations by averaging the costs over the useful life of the machine.

The time value method is like comparing the value of receiving $100 today versus$100 a year from now. The immediacy of receiving money today means you can invest it sooner. The average annual investment method uses a more straightforward approach, similar to budgeting for monthly expenses – you just look at the average costs rather than detailed monthly variations.

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.

The time value method acknowledges that money has a different value depending on when it is received. Cash inflows and outflows occur at various intervals, and by using this method, you convert all cash flows to their equivalent values at a specific time, ensuring rational comparisons and analyses.

Consider a person deciding between receiving $1,000 today or$1,000 a year from now. Under the time value of money principle, the $1,000 received today can be invested to earn interest, thus increasing its overall value, unlike waiting a year for the same amount.

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 estimates the cost of investment as a percentage of the average value of a machine over its useful life. This method simplifies calculations by averaging the machine’s depreciating value, providing a more straightforward way to estimate the annual ownership cost.

Imagine a student with a laptop that depreciates in value over time. Instead of tracking its exact value each year, they can estimate their 'average' cost by considering what the laptop was worth at the start and what it might be worth by the end, thereby making budgeting for repairs and upgrades easier.

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.

The total ownership cost includes several components: depreciation (loss in asset value over time), investment cost, insurance, property taxes, and storage costs. Each of these components must be considered when calculating the overall cost of ownership for machinery.

When you own a home, your expenses extend beyond just the mortgage payment. You need to budget for property taxes, home insurance, maintenance, and repairs, just like machinery ownership extends beyond just the initial purchase price.

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