6.2. Comparison of Methods

The initial cost is converted into equivalent uniform annual cost, annualized cost we call it as annualized initial cost using uniform series capital recovery factor. So the initial cost is nothing but your ₹2,89,00,000 multiplied by the uniform series capital recovery factor which is nothing but i into (1 + i)^n / [(1 + i)^n - 1]. The interest rate is 8 percent and n is 12.5 years. So you can get the annualized initial cost as ₹37,41,844.41 per year.

To calculate the equivalent uniform annual cost, we take the initial cost of an investment and convert it into a series of equal yearly payments. This is done using the uniform series capital recovery factor formula, where 'i' is the interest rate (8%) and 'n' is the lifespan (12.5 years). By plugging in the numbers into the formula, we find that the annualized cost is ₹37,41,844.41. This means that treating a one-time capital investment like a loan, the annual payment needed to cover this cost at an 8% interest rate over 12.5 years is approximately ₹37.4 lakh.

Think of it like buying a car. You might pay ₹2,89,00,000 upfront, but if you take a loan and pay it off with interest over a number of years, you’ll actually be paying a certain amount each year. For budgeting, it's much easier to think about how much you need to set aside yearly than to remember the total upfront cost.

Now I need to convert the future salvage value into equivalent uniform annual cost. The equivalent uniform annual cost of salvage value = Salvage value × [i / ((1 + i)^n - 1)]. Salvage value is 20% of the initial cost. Here, Salvage value = 0.2 × ₹2,89,00,000 = ₹57,80,000.

Salvage value is what you expect to get from the asset at the end of its useful life. In this case, it is assumed to be 20% of the initial cost, which is stipulated as ₹57,80,000. To convert this future amount into an equivalent annual cash flow, we again use a derived formula similar to the one used for the annual cost, allowing us to perceive the future value in today's terms. By substituting values, we find the annualized salvage value to be approximately ₹2,85,968.88.

Imagine selling an old car after several years; even if it depreciates, you will gain some money from the sale. You can think of the car’s resale value as salvation money that you can count on years from now, and by allocating a portion of this amount to your yearly budget, you can better prepare for future expenses.

Hourly depreciation = (Annualized initial cost - Annualized salvage value) / Annual use in hours. So, hourly depreciation = (₹37,41,844.41 - ₹2,85,968.88) / 1600 = ₹2159.92/hour.

Hourly depreciation provides insight into how much value the asset loses per hour of operation. It is derived by taking the difference between the annualized costs (initial cost and salvage value) and dividing that by the total operational hours in a year (1600 hours). This equates to an hourly loss of value of ₹2159.92, representing the wear and tear of the equipment over time.

Think of it like a subscription service; if you pay ₹5000 a year for a service that you used for 1600 hours, you're effectively using about ₹3.12 of that service each hour you use it. Similarly, the equipment's hourly depreciation gives you an idea of how much value it loses as you use it.

Other components of the ownership cost such as insurance, taxes, and maintenance are calculated as a percentage of the initial cost minus the tire cost. For example, insurance is 2% of the adjusted initial cost divided by annual usage, yielding an hourly insurance cost of ₹361.25/hour.

To calculate ownership costs, several factors must be considered—insurance, taxes, and so forth. Insurance is calculated as a small percentage of the equipment's value (in this case, 2%), divided by its operational hours (1600 hours), resulting in an hourly cost of ₹361.25. This systematic approach helps track how other lagging expenses can accumulate over time, impacting overall operational costs.

Just like insuring your car—where your annual premium is calculated based on the car's value—here, equipment ownership costs take a similar approach. It's smart to account for such components in your budgeting to avoid surprises.

The total hourly ownership cost combines depreciation, insurance, and taxes: ₹2159.92 + ₹361.25 + ₹541.88 = ₹3063.05/hour. Adding operator wages makes the total operating cost ₹5759.20/hour.

To finalize the cost of operating the equipment, we sum all the various components we calculated earlier, resulting in a total hourly ownership cost of ₹3063.05. Including the operator's wages of ₹200/hour brings the total cost of utilizing the equipment to ₹5759.20/hour. This comprehensive overview is essential for laying out the expense base for efficient operations and resource allocation.

You can think about this like costing every minute of your time when running a business: if you calculate all your expenditures, such as the rent, utilities, and employee wages, you can determine how much every hour of operation is costing you, ensuring you're aware of when to scale back or invest more.

There are different methods to estimate equipment costs, such as the Caterpillar method, which is based on average annual investments, while the time value concept method provides a more accurate estimate. The choice of method often reflects a company’s internal policies.

Different methods for estimating equipment costs can yield various results, where the Caterpillar approach approximates costs based on average annual investments, while considering the time value method factors in cash flows and gives more substantial estimates. Companies have the liberty to select the estimation method that aligns best with their organizational policies and requirements, aiming for accuracy in financial planning.

Imagine choosing different budgeting strategies for a vacation; some might prefer estimating costs based on average expenditures (Caterpillar method), while others may calculate the present value of future savings to invest today (time value method). Just like budgeting, companies select estimation methods based on their perception, accuracy needs, and operational strategy.

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