Cost-Benefit Analysis: Should a Contractor Buy an Earthmover?

Introduction

In the construction industry, making the right equipment investment decisions is crucial for contractors. One such decision is whether to purchase an earthmover or continue renting one. In this essay, we will perform a cost-benefit analysis to help a contractor determine how many days per year they would need to operate the earthmover to make it a worthwhile purchase. To make an informed decision, we’ll consider the initial purchase cost, maintenance expenses, operating costs, rental alternatives, salvage value, and the contractor’s required interest rate.

Costs Involved

Initial Purchase Cost: The earthmover costs $250,000 upfront.

Maintenance Costs: The contractor will incur annual storage and maintenance costs of $5,000.

Operating Costs: When in use, the earthmover costs $300 per day to operate.

Rental Costs: Alternatively, renting an earthmover would cost $500 per day, including operating expenses.

Salvage Value: The contractor expects to sell the earthmover at a salvage value of $20,000 after 20 years.

Interest Rate: The contractor requires a 10% interest rate on any investment.

Cost-Benefit Analysis

To determine the number of days per year the contractor should operate the earthmover, we need to calculate the annual cost of owning and operating it versus the annual cost of renting. Let’s break down the costs:

A. Annual Ownership and Operating Costs:

Maintenance Costs: $5,000

Depreciation (Initial Cost – Salvage Value / Useful Life): ($250,000 – $20,000) / 20 = $11,500 per year

Operating Costs (assuming 20 operating days per month): $300/day x 20 days/month x 12 months/year = $72,000 per year

Total Annual Ownership Costs: $5,000 + $11,500 + $72,000 = $88,500

Annual Rental Costs:

Rental Costs: $500/day x 20 days/month x 12 months/year = $120,000 per year

Now, let’s calculate the annual savings from owning the earthmover instead of renting:

Annual Savings = Annual Rental Costs – Annual Ownership Costs Annual Savings = $120,000 – $88,500 = $31,500

To determine how many days per year the contractor should operate the earthmover to break even, we can divide the annual savings by the difference in daily operating costs:

Break-Even Operating Days = Annual Savings / (Operating Cost with Rental – Operating Cost with Ownership) Break-Even Operating Days = $31,500 / ($500/day – $300/day) = $31,500 / $200/day = 157.5 days

Conclusion

To make purchasing the earthmover a worthwhile investment at a 10% interest rate, the contractor should aim to operate it for at least 158 days per year. Beyond this threshold, owning the earthmover will yield cost savings compared to renting. This analysis highlights the financial aspects that contractors should consider when deciding whether to purchase or rent heavy equipment for their construction projects, ensuring they make informed and economically sound choices.