3. Costs Associated with the Machine

So, basically that is what is this economic life. Economic life means it is a time during which the cost of holding the machine will be minimum. So, beyond the economic life you can see that there will be increasing costs associated with the machine, either due to increase in the operating cost that is repair and the maintenance costs or increase in downtime costs or increasing obsolescence cost.

The concept of 'economic life' refers to the duration during which a machine incurs the lowest costs for the owner. Initially, costs associated with the machine, such as repairs, maintenance, and downtime, are relatively low. However, once the machine has exceeded its economic life, these costs begin to rise significantly. This phenomenon occurs due to wear and tear, inefficiencies, and potential obsolescence as newer technologies emerge.

Consider a smartphone. When you first buy it, it runs smoothly and efficiently. Over time, as the phone ages, it may require more repairs, may not support newer apps, and could become slower. Thus, it may cost you more to keep an old phone than to invest in a new one, similar to how machines operate in terms of economic life.

In this example, we are going to see how to estimate the economic life of the machine. So, basically, so, here we are going to estimate economic life for a track mounted front shovel. The purchase price is 35,00,000. So, the machine is expected to last for 8 useful years and the depreciation is assumed to follow double declining balance method.

To estimate the economic life of a machine like a track-mounted front shovel, we take into account the initial purchase price and the expected useful life—in this case, 8 years. We also consider how the value of the machine decreases over time using a depreciation method known as double declining balance, which accelerates depreciation in the earlier years of the machine's life. This method helps owners understand how much value they are losing each year.

Imagine buying a new car for 35,00,000. You expect to use it for 8 years, but each year the car loses its value more quickly initially, due to depreciation, just like the machine loses value through the double declining balance method.

Due to inflation, you can see that annual increase of the average cost of the equipment is approximately 6%. That means, the machine cost is going to increase by 2,10,000 every year, due to the effect of inflation.

Inflation causes the cost of machinery to rise over time. In this case, a 6% annual inflation rate means that the cost of the machine will increase by 2,10,000 each year. This increase affects the decision to replace the machine, as the higher future replacement cost must be considered in the overall financial analysis.

Think of groceries—if you buy a basket of groceries for 2,000 today, you might find that same basket costs 2,120 next year due to inflation. Just like how your grocery bills increase, the machine's cost also rises, influencing when to replace it.

For calculating the hourly maintenance and the repair cost, downtime cost and the obsolescence cost of the machine, we have to use the following values and the equipment cost is given approximately as rupees 900 per hour. So, every year maintenance and repair costs is given for the entire useful life of the machine.

To determine the total cost of running a machine, factors such as maintenance and repair costs, as well as downtime costs, must be analyzed. The costs are approximately 900 rupees per hour, and as the machine ages, these costs tend to increase. Regular analysis helps in forecasting the total cost of ownership and understanding when the machine might become unprofitable.

Think of a restaurant. The cost of running a kitchen goes beyond just the food you buy; it includes maintenance of ovens, refrigerators, and even the cost of fixing them when they break down. As equipment ages, these maintenance costs can rise, much like how machinery costs increase over time.

Downtime is nothing but the non availability of your machine for the productive work. So, it may be either due to the breakdown of the machine.

Downtime refers to periods when the machine cannot operate, often due to repairs or maintenance. These periods represent lost production time and can significantly impact profitability. As machines age, they tend to have more downtime, which results in increased costs associated with lost productivity and potential revenue.

Imagine a bakery that has an oven malfunction. If the oven is broken for a day, the bakery can't produce its bread and pastries, leading to lost sales. This loss of productivity during downtimes is financially impactful for the business, just as increasing downtime costs affect the overall operating costs of equipment.

The obsolescence cost is also important as the age of the machine increases, it becomes obsolete you know that. So, there may be different reasons for the obsolescence either due to technological obsolescence, that is due to wear and tear, its productivity may get reduced, or it may be even due to market obsolescence.

Obsolescence costs arise when a machine becomes outdated or less efficient compared to newer models. This can occur due to technological advancements or shifts in market demand. As the machine ages, its relevance diminishes, leading to potential income loss or the need for more frequent maintenance to keep it operational.

Consider older smartphones that can't run the latest applications because they don't have the hardware capacity. Users often gravitate towards newer models with better features. Machines also become less desirable as technology progresses, similar to how phones get replaced faster as new innovations emerge.

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