2.3. Estimated Annual Cost Comparison

So, depreciation for the first year is nothing but 0.4 into book value. D = 0.4 × 28,00,000 = 11,20,000 rupees. So, now you calculate the book value at the end of first year, so what is the book value at the beginning of year that is nothing but your purchase price of the machine 28 lakh minus the depreciation for the first year. That is nothing but 11,20,000, that gives you the book value at the end of the first year as 16,80,000 so hope you can understand. So, let us work it for the second year.

In this chunk, the depreciation for the first year is calculated using a formula where the depreciation (D) is equal to 0.4 multiplied by the book value of the machine. Given that the purchase price of the machine is 28,00,000 rupees, the first-year depreciation sums up to 11,20,000 rupees. Next, to find the book value at the end of the first year, the depreciation amount is subtracted from the original purchase price, leading to a book value of 16,80,000 rupees at the year’s end.

Consider a car that you bought for 28,00,000 rupees. After one year, the car loses value due to depreciation. If we assume this loss is 40% of the original value, you'd calculate how much value the car retains at the end of that year. Subtracting 11,20,000 rupees (the depreciation) from the original price gives you an idea of what your car is worth now.

So, for the second year the depreciation is nothing but D2 is 0.4 into book value the end of first year, D = 0.4 × 16,80,000 = 6,72,000 rupees. Now calculate the book value at the end of second year, it is nothing but book value at the end of the first year minus the depreciation for the second year. So, what is the book value at the end of first year? It is nothing but 16,80,000 minus your depreciation for the second year is 6,72,000 that gives me the book value at the end of second year as 10,8000.

In the second year, the depreciation is again calculated using the formula, now applied to the book value at the end of the first year, which is 16,80,000 rupees. The resulting depreciation for the second year comes out to be 6,72,000 rupees. The book value at the end of the second year is calculated by taking the previous year's book value and subtracting the current year's depreciation, resulting in a new book value of 10,80,000 rupees.

Imagine your car continued to lose value in the second year as well. After its first-year depreciation, it’s worth 16,80,000 rupees. If it loses another 40% of this value in the next year, you'll need to calculate its worth again, subtracting 6,72,000 rupees from the new value, helping you understand how much your car depreciates over time.

So, like this you calculate the depreciation for all the years and the corresponding book values also you have to estimate. Now you can estimate the annual cost by adding the operating and the maintenance cost as the depreciation. When you add column 2 and the column 3 you will get the annual costs for every year. So, what is the annual cost for the first year? Your operating in the maintenance cost for the first year is 12 lakh and your depreciation for the first year is 11,20,000, so your annual cost will be Annual cost of first year = 11,20,000 + 12,00,000 = 23,20,000 rupees.

After calculating depreciation for each year, you add the operating and maintenance costs alongside the depreciation to find the total annual cost. For the first year, the operating and maintenance costs sum to 12 lakh rupees, and with the depreciation added, the total annual cost reaches 23,20,000 rupees. This method of calculating helps in understanding yearly expenses comprehensively.

Think of running a restaurant. You calculate both the ingredient costs (operating) and the rent or wages (maintenance) to find out what it costs to operate per year. Just like totaling everything to see yearly expenses, here you combine various costs related to your machine to get a complete picture of its annual cost.

Annual cost of second year = 6,72,000 + 12,60,000 = 19,32,000 rupees. So, like this you keep calculating for all the years with every year you can calculate the annual cost. Then you can calculate the cumulative cost, then find the average annual cumulative cost. So, like we did for the earlier old loader or the current loader or the defender.

Continuing from the first year, the annual cost for the second year is calculated similarly, yielding 19,32,000 rupees by adding depreciation for that year (6,72,000 rupees) and the operational costs. Then, after calculating annual costs for each subsequent year, the cumulative costs can be summed, and the average annual cumulative cost can be determined. This comprehensive analysis allows for better decision-making regarding equipment lifecycle.

Similar to tracking expenses over time in a business, where you keep a record of total costs year over year to know how much you're spending overall and what your average yearly spending looks like. By calculating these clearly, you can judge if your investments are yielding the returns you expect over time.

So, as per Dr. James Douglas guideline the estimated annual cost of the current machine for the next year exceeds the minimum average annual cumulative cost of the proposed machine. So, you are going to compare the annual cost of the current machine for the next year with the minimum average annual cumulative cost of the proposed machine.

This section discusses how to determine when to replace a machine by comparing the estimated annual cost of the current machine for the upcoming year against a predetermined threshold (the minimum average annual cumulative cost). If the current machine's cost exceeds this threshold, it's an indicator that a replacement might be warranted. This proactive approach ensures financial efficiency.

Imagine you are deciding whether to keep an old car or buy a new one. If maintaining the old car starts costing more than it would to lease or buy a new car (considering all costs), it may be time to replace it. This analogy helps clarify how you assess whether sticking with current equipment is wise or whether to invest in something new.

--