4.1. Payback Period Explanation

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.

This chunk introduces how to calculate depreciation and how it affects the book value of a machine. The formula for calculating depreciation is straightforward: for the first year, it is 40% (0.4) of the machine's purchase price (28,00,000 rupees). This results in a depreciation amount of 11,20,000 rupees. The book value at the end of the first year is then calculated by subtracting this depreciation from the purchase price, giving a new book value of 16,80,000 rupees at the end of the year.

Imagine you buy a car for 2,800,000 rupees, and it depreciates at a rate of 40% in the first year. After one year, you would subtract 1,120,000 rupees from your original purchase price to find out how much the car is worth. Just like how your car loses value over time, machines lose value too, and understanding this helps to manage costs effectively.

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.

In this chunk, we proceed to the second year’s calculations. The depreciation for the second year (D2) is also calculated using the same rate of 40%. This time, it is applied to the new book value (16,80,000 rupees) from the previous year, resulting in a depreciation of 6,72,000 rupees. To find the book value at the end of the second year, we subtract this new depreciation from the ending book value of the first year, which gives us a book value of 10,08,000 rupees at the end of the second year.

Continuing with our car example, after the first year, the car is worth 1,680,000 rupees. If it depreciates again by 40%, we find that it loses another 672,000 rupees. Each year, just like the car, its value continues to decrease, which is critical for understanding long-term costs and planning for future investments.

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.

This chunk focuses on how to estimate the annual costs associated with owning the machine. Annual cost is determined by summing up the operating expenses and the depreciation for a given year. For the first year, the operating and maintenance costs are given as 12,00,000 rupees, and adding this to the depreciation amount (11,20,000 rupees) results in a total annual cost of 23,20,000 rupees. This same process is used to calculate annual costs for subsequent years, based on the respective depreciation and operating costs.

Think about budgeting for running a household—just like you add up your costs for rent or mortgage, groceries, and cleaners, you need to add up the costs associated with the machine (like maintenance and depreciation) to understand how much it really costs to operate. Knowing your total costs helps you plan your finances effectively.

Now you can calculate the cumulative cost, then find the average annual cumulative cost. It is nothing but your cumulative cost divided by the cumulative usage of the machine.

The process of calculating average annual cumulative cost helps in assessing the overall efficiency of managing the machine's financials over the years. Cumulative cost accumulates the total costs over the years, and by dividing this figure by the cumulative usage, you can determine how much each unit of usage costs on average. This understanding helps in strategic decision-making regarding the future usage of the machine.

Consider a gym membership. If you pay a total of 24,000 rupees over a year and go to the gym 12 times, the average cost per visit is 2,000 rupees. Similarly, calculating the average annual cost of using a machine tells you if it’s worth the money based on how often it gets used.

So, the economic life of the machine is 9th year for the proposed loader, because the cost is minimum 9th year.

This chunk reports the conclusion regarding the economic life of the machine, which is identified as the year in which the average annual cumulative cost reaches its lowest point. In this case, it is stated that the proposed loader’s economic life is determined to be the 9th year. Understanding the economic life is crucial for determining when a machine should be replaced to maximize investment returns.

Imagine investing in a phone. You might find that after three years, its value and functionality drop significantly. Identifying this time frame helps you decide the best moment to upgrade for improved performance and value—similar to recognizing when a machine's costs outweigh its benefits.

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