7.1. Summary of Key Learnings

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 your uniform series capital recovery factor, which is nothing but I into (1 + i)^n by (1 + i)^n - 1.

To estimate annual costs for using equipment, we convert a one-time purchase cost (initial cost) into an annualized cost. The formula used involves the initial cost multiplied by a uniform series capital recovery factor, which accounts for the interest rate and the lifespan of the equipment. Here, the initial cost of the equipment is ₹2,89,00,000, the interest rate is 8%, and the lifespan is 12.5 years. By applying the formula, we find that the equivalent uniform annual cost is approximately ₹37,41,844.41 per year.

Imagine buying a car. If you spend ₹2,89,00,000 on it, but instead of thinking of it as just a one-time payment, you want to know how much it costs you each year for budgeting purposes, you treat it like a loan you're repaying over multiple years with interest.

So now I need to convert the future salvage value into equivalent uniform annual cost. The salvage value will be converted into equivalent uniform annual cost using uniform series sinking fund factor.

The salvage value is the expected amount you can sell the equipment for at the end of its useful life. To convert this future value (let's say 20% of the initial cost, which amounts to ₹57,80,000) into an annualized cost, we use the sinking fund factor formula. This conversion helps us understand how much to reserve each year to be able to recover this value by the end of the equipment's life. The annualized salvage value turns out to be approximately ₹2,85,968.88 per year.

Consider a smartphone that you expect to sell after a few years. If you bought it for ₹57,80,000, you might anticipate selling it for ₹11,56,000. Thinking ahead, you start setting aside money each year, just as you might set aside savings to ensure you have enough for a new phone.

Hourly depreciation is the difference between the annualized initial cost and the annualized salvage value divided by the annual usage of the machine in hours.

Here, hourly depreciation is calculated using the formula: (Annualized Initial Cost - Annualized Salvage Value) / Annual Usage of the Machine in Hours. If the equipment is used 1600 hours per year, we subtract the annualized salvage value (₹2,85,968.88) from the annualized initial cost (₹37,41,844.41), which results in ₹34,55,875.53. Dividing this figure by 1600 hours gives an hourly depreciation rate of approximately ₹2,159.92. This represents the cost allocation for using the equipment each hour based on its wear and tear.

Think of it as renting an apartment. You pay rent monthly, but if you wanted to find out how much it costs you each hour to live in that apartment, you'd take your total annual rent, deduct any amounts you expect to recover if you move out, and then divide it by the number of hours you live there each year.

Now adding other components of ownership costs including insurance, taxes, and storage as a percentage of initial costs minus tire costs.

Ownership costs for machinery include not only depreciation but also additional expenses like insurance and taxes. For example, if insurance is calculated as 2% of the initial cost (less any tire costs), the hourly insurance cost is ₹361.25 when divided by the total operating hours (1600). Similarly, taxes can also be calculated as a percentage of the adjusted initial cost, resulting in an hourly tax cost of ₹541.88. These components help provide a more complete understanding of the total costs of owning and operating equipment.

Think about owning a house: the mortgage (like the initial cost), property tax (like the taxes), and homeowners insurance are all costs that add up. Just like you want to know what the total cost of living there will be each month, we want to sum all these ownership expenses for machinery too.

Total hourly ownership cost is calculated by summing depreciation, insurance, and taxes.

The total hourly ownership cost combines all the previously mentioned costs: hourly depreciation (₹2,159.92), insurance (₹361.25), and taxes (₹541.88). By summing these figures, the total hourly ownership cost comes out to ₹3,063.05 per hour. This total gives a clear view of the fixed costs associated with operating the machinery without considering operating costs like fuel.

This is like determining how much it costs to run your vehicle, including your monthly car payment, insurance, and any taxes or fees, without including fuel or maintenance costs. This helps you budget more accurately for your vehicle's total ownership.

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