Ownership cost is defined as the total cost related to the construction equipment in order to own it. This cost is irrespective of whether the equipment is employed or not.
Ownership cost is a combination of different costs like initial cost, interest cost, salvage value, insurance cost, storage cost and taxes. Each cost is briefly explained one by one in this article.
Components of Ownership Cost
The components of ownership cost are:
- Initial Cost
- Salvage Value
- Insurance Cost
- Storage Cost
- Interest Cost
1. Initial Cost
Initial cost of an equipment includes:
- The cost of equipment, transportation cost and the sales tax to bring the equipment to the company hold.
- Cost of assembly of the equipment.
- Installation cost of the equipment.
Hence, the initial cost is defined as the capital investment that is required to own the equipment.
The construction equipment can be mounted over pneumatic tires in certain situations. In this condition, the ownership cost is the initial cost minus the cost of the tire. This deduction is made because the pneumatic tires have lesser life compared to the equipment. Another reason behind this is that the cost of the tire is considered as the operating cost of equipment.
With the prolonged use of equipment for construction, it possesses a depreciation value with time. This is caused due to wear, tear and obsolescence.
2. Salvage Value
Salvage value is defined as the final value of equipment that is received once it has reached its useful life. The salvage value is mainly obtained by referring to the data that is obtained from past projects that required the use of similar construction equipment.
Read More: What is Salvage Value in Construction?
3. Interest Cost
Interest cost is also called a cost of capital investment. The interest cost can be defined as the annual cost of interest that is incurred on the borrowed money in order to acquire the ownership of the equipment.
There are two cases, wherein the equipment can be purchased by borrowing money from a lender or can be purchased by using the funds of a construction firm. For the first case, the interest is charged on the borrowed amount. For the second case, the interest charged is equal to the construction firm’s rate of return.
Considering the time value of money and following apporpriate compound interest factors helps to calculate the interest cost. The interest cost can also be calculated as percentage of constant average annual investment cost over the useful period of the construction equipment.
Annual Interest Cost = Annual Interest rate or rate of return x Average annual Investment.
4. Insurance Cost
Insurance cost is defined as the premium amount that is paid to the insurance company in order to cover the loss faced due to fire, theft or any accident for the construction equipment. Hence insurance cost is the cost that protects the owner’s construction equipment from any damages mentioned above.
Insurance cost can be calculated as a percentage of the average annual investment or the book value in a year. Generally, insurance cost accounts to 1 to 3% of the average annual investment.
Tax is the money that has to be paid to the state or the central government which is a representation of property tax. The property tax is dependent on the value of the equipment and the tax rate recommended for a particular region.
Property tax = Percentage of book value in a given year [ 2 to 5% of book value or average annual investment]
6. Storage Cost
Storage cost is the cost of storing the equipment in the storage area of the company when it is not operated for construction purposes. This cost is a combination of rent of storage yard, the wage of security guards, rent of maintenance, wages of the workers who transport and moves to the storage yard.
Storage Cost = 0.5 to 1.5% of the average annual investment or book value of the construction equipment.
Calculation of Ownership Cost
Total Annual Ownership Cost = Depreciation cost + Investment cost + tax + insurance cost + storage cost
Hourly Cost of Ownership = Annual Ownership Cost/ Number of operating hours the equipment operates annually