Canada: Who Doesn't Love New Equipment?

Last Updated: August 27 2014
Article by James Byrne

Everyone loves new gear. Why wouldn't you want to have new equipment working in your operations? As an accountant I sometimes have to play the role of the wet blanket and ask the question: "Is it the right thing to do?" Sometimes it will be the right decision, sometimes it may not. We all know that over time, your gear will eventually need to be replaced, or a situation will arise where you don't have the right tools for the job. Undoubtedly, the equipment will begin to fail and productivity and cost-effectiveness of using a previously reliable machine will drop, or simply a new situation will pop up and you don't have the needed equipment configuration. Determining when the time is right to replace the aging equipment or to keep repairing it is not so easy to assess. The answer comes down to knowing your costs, and knowing that you will be able to recover your costs with a suitable amount of work at a good rate for the services you are providing.

Determining whether you should repair your current equipment or purchase new comes down to comparing the cost of the two alternatives and assessing the best option for your business.

A cost comparison

In order to determine when the time is right to replace a piece of equipment, one must consider the costs that go into operating both the existing piece of equipment and the potential new piece of equipment. Some costs are very obvious, some are not so obvious and will require some thought and consideration. The costs related to operating equipment are typically broken down into four basic components. This is typically done on some sort of unit basis to allow for the easiest comparison. The most common cost per unit is cost per hour or an easier concept to wrap your head around is annual cost basis.

Components of equipment cost:

  1. Ownership – Depreciation, interest, insurance
  2. Maintenance – Major rebuilds, ongoing service and repair, other
  3. Consumables – Fuel, tires, tracks, etc.
  4. Operator – Operator wages and benefits

Determining the operator cost per hour is relatively straightforward. The operator costs of running a new purchase or the existing piece can be considered to be the same and are not considered in the cost comparison. However, if you are considering whether you should purchase an asset for a new work type, consideration of the labour cost is a must.

The focus following is on the other three cost components and require some work when comparing your existing piece of equipment to a potential new piece.

Ownership:

  • Depreciation: To calculate your depreciation on an hourly basis one needs to know the initial cost, the ending salvage value or end value, and the estimated life of the equipment, typically considered in hours. When assessing an "old" piece of equipment the initial cost would be the current market value, and the estimated life would be the remaining working life.
  • Interest: The interest cost represents the cost of tying up capital to purchase the asset, regardless of whether you borrow or not. If you buy the asset directly you are still tying up your capital and this represents a cost to your operations. Interest cost is calculated based on the average value of the asset over its life.
  • Insurance: Insurance costs related to the equipment.

Maintenance:

  • Major rebuilds: Over the life of the asset what major rebuild costs will be incurred? This overall cost is then averaged to a yearly or hourly basis depending on your unit of comparison. When looking at your existing piece of equipment, what will your costs be to just to get it to the end of its service life?
  • Ongoing service and repair: What are the daily wear and tear maintenance costs and servicing? These can be considered on an annual basis and adjusted to an hourly basis if needed.

Consumables:

  • Fuel: The hourly consumption per litre or gallon, multiplied by the fuel price.
  • Tires / tracks: On an annual basis how many tires or tracks will require replacing and at what cost?
  • Supplies: These will be the smaller items related to the operation of the asset, but add up over time. Grease, lube, chains, hoses, etc.

Below is a sample calculation to demonstrate the costs discussed.

New Loader

Existing Loader

Annual hours per year

1,500

1,500

Purchase price / market value

600,000

175,000

Salvage Value

85,000

85,000

Years of service remaining

6

2

Depreciation per year

85,833

45,000

Interest rate

6.00%

6.00%

Interest expense

20,550

7,800

Insurance

12,000

3,500

Total Ownership Costs

118,383

56,300

Major rebuild (Average cost per year)

20,833

42,500

Annual costs of R&M

30,000

50,000

Total Maintenance Costs

50,833

92,500

Fuel costs

52,500

60,000

Consumables

6,000

7,500

Supplies

5,000

5,000

Total Consumable Costs

63,500

72,500

Total Comparison Cost

232,717

221,300

Total Comparison Cost Per Hour

155.14

147.53

5% productivity improvement

2.25

-

Rate (assume $4.50 / m3)

10.13

-

Total Revenue Benefit

15,188

-

Total Comparison Cost

217,529

221,300

Total Comparison Cost Per Hour

145.02

147.53

Now what?

If the calculated annual costs of the new loader show that it offers a definite advantage over the existing loader, you could be comfortable in selecting the better alternative. However, it's never that easy and what if the annual costs of the old loader and the new loader are not that different?

The factors to consider if the annual costs are not that different; which option has the smaller investment and has the shorter life? Or are you expecting a significant change to the technology to come about or become available in the near future? Does the new engine have lower fuel consumption, or new head attachment controls?

An important consideration is which option has the greater output capacity, safety and reliability. Reliability is one of the largest influences on the profitability of many operations. The logistics of many remote jobs are difficult to manage as it is. When a key piece of equipment goes down unexpectedly for a couple of days the whole flow of the job is affected. Putting a cost to this disruption factor is something that must be considered carefully.

Final thoughts

Adding a new or slightly used piece of equipment to your fleet is never a simple decision and will have noticeable impacts to your financial position. Some decisions will be easy and will be "must have" purchases. However, other purchases and decisions will not be so apparent. Ensuring that you are collecting the necessary information and evaluating your decisions in a reasonable manner will help ensure that your operations remain in good operating condition both mechanically and financially.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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