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Machinery Management. Machinery is a tremendously important part of agricultureGood management should be able to calculate cost of ownership
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1. DCC Farm/Ranch Business Management Machinery Economics
2. Machinery Management Machinery is a tremendously important part of agriculture
Good management should be able to calculate cost of ownership & cost of operation for any piece of equipment
Easy to underestimate machinery costs
3. Ownership Costs - Fixed Costs associated with owning a fixed input or resource
Ownership costs begin with the purchase of a piece of equipment and continue for as long as the piece of equipment is owned
Cannot be avoided, until machine is sold
These costs are incurred even if the input is not used
Costs include Depreciation, Interest, Taxes, Insurance, Housing, and Leasing
4. Ownership Cost: Depreciation
Non-cash expense that reflects loss in value due to age, wear and obsolescence
Accounting procedure that spreads the cost of the asset out over the life of the asset, thus recovering the initial purchase price
5. Ownership Cost: Depreciation Formula:
Purchase Price Salvage Value
Ownership Life
Salvage Value
See Table 1 in Appendix for estimates
IRS regulates which methods of depreciation can be used for tax purposes
The IRS methods may not truly reflect the actual annual depreciation
6. Ownership Cost: Interest Interest here can refer to interest charged for Debt &/or Equity
If borrowed capital is used to buy the machinery, interest is the loan interest rate
But what if the machinery is bought using Equity capital (paying down debt with cash, partial cash payment for equipment, equipment trade in, etc)?
Interest in this case is an opportunity cost
Opportunity Cost: Fact that ever input or resource has an alternative use, even if alternative is not in use
It prevents the capital from being used for an alternative investment
Investing in machinery ties up capital, money could be used elsewhere maximizing return to equity
7. Ownership Cost: Interest Depending on the source of the capital, proper use of interest is the lenders interest rate for borrowing capital (Debt Financing), rate of return on alternative investments (Equity Financing), or a weighted average of the two
Formula:
Average Value = Purchase Price + Salvage Value
2
Interest = Average Value x Interest Rate
Average Value is the value at midlife, or average value
Since value declines over its lifetime, average value used to determine average interest charge
8. Ownership Costs: Taxes Some states levy property taxes on farm machinery
Montana has property taxes assessed on livestock, farm machinery, heavy equipment, automobiles, trucks and business equipment
Charge depends on the valuation procedure and tax rate in each area
For Montana - propertys value is multiplied by tax rate (set by legislature) to determine taxable value
Taxable value multiplied by mill levy established by tax jurisdiction
9. Ownership Costs: Taxes Formula:
Average Value x Taxable Value Rate x Millage Rate
1,000
Taxable Value Rate for Equipment in Big Horn County = 3%
Millage Rate for Hardin = 536.54
Estimation of property taxes is about 1% of the average machine value
Pickups and trucks, which also have license costs, should use higher estimate
10. Ownership Cost: Insurance
Annual charge for insurance to cover damage; fire, theft, hail, other liabilities
Annual ownership cost should include insurance, even if the owner carries no insurance and personally takes the risk
Some losses can be expected over time, and the owner will need to cover these damages
Formula:
Average Value x Premium Rate
1,000
Estimation of insurance is about 0.5% of average machine value
This would be higher for vehicles that are on-road because of higher premiums for property damage, collision, and liability coverage
11. Ownership Cost: Housing
Housing of machinery
Estimation of 0.5-1.5% of average value of machine
Housing charge can also be estimated by calculating annual cost per square foot for the machine shed and multiplying by number of square feet machine occupies
Ownership charge for housing should be considered even if machinery is not housed
Cost would reflect additional wear and tear
Study found that tractors left outside had 16% lower trade in value after 10 years than tractors that were kept inside
12. Ownership Cost: Leasing Leasing:
Some machinery is not owned, but under long-term lease agreements
This lease payment should be included as an ownership cost
13. Operating Costs - Variable Operating costs are directly related to use
Costs in which management has control at a given point in time
Can be increased or decreased at managers discretion
Will be increased as production increases
If machine is not used, operating costs are zero, but they increase directly with amount of annual use
Costs include; Repairs, Fuel & Lubrication, Labor, Custom Hire or Rent, and Other
14. Operating Costs: Repair Annual repair cost will vary with use, machine type, age, preventive maintenance, and other factors
Repair costs usually increase over time
Highly variable, so any rule of thumb should be used with caution
Lost of data that surveys machinery and provides average repair costs per 100 hours of use, and lists as a percent of list price
See Table 2 for Repair Estimates
Best method for information is record of actual repairs for each machine
15. Cost Curve
16. Operating Cost: Fuel/Lubrication Gasoline, diesel, oil, grease, and filters
Fuel use will depend on engine size, load, speed, and field conditions
Farm records can provide average fuel use
University of Nebraska tests:
Gallons per hour = 0.043 x maximum rated PTO horsepower (diesel)
Gallons per hour = 0.060 x maximum rated PTO horsepower (gasoline)
Fuel usage can also be estimated from tables (fuel usages researched by universities)
Actual results can vary up to 30% either way of the table
Depth of tillage, soil conditions, and speed variables
Grease, oil, and filters average about 10-15% of fuel costs for self powered machine
17. Operating Costs: Labor Labor depends on operation being performed, field speed and efficiency, size of machinery being used
Underestimated if only factor in-field time
Should include time spent fueling, lubricating, repairing, adjusting, moving between fields, etc
Common to assign 20% extra to out-of-field time
Labor = 120%
18. Operating Cost: Custom Hire Custom Hire:
Custom operator hired to perform machinery operations, these costs should be included in machinery operating costs
Other:
Twine, plastic wrap, bags, etc
19. Machinery Cost & Use Total Costs:
Annual total ownership/fixed costs are assumed to be constant regardless to the amount the machine was used during the year
Operating costs increase with the amount of usage, usually at a constant rate per acre or per hour
20. Machinery Cost & Use Average Costs:
For decision making purposes, useful to look at machine costs in terms of average cost per acre, per hour, or per unit
Average fixed costs will decline as hours, acres, units of output, increase
Average total costs (fixed + variable) will also decline with additional units
Average variable costs will remain fixed
See Table 3 for Total and Average Machinery Costs
21. Hours of Use How many hours will I need this piece of equipment for per year?
Historical data
In absence of historical data, calculate either of the following for reasonable estimates:
Machinery rated in miles per hour
Machinery rated in tons per hour
22. Estimating Hours of Use First, look up in Table 1, machinery efficiency coverage
Field efficiency is to recognize that machine is not used 100% of it maximum capacity due to:
Overlap, turning, adjusting, lubricating, handling material
Seeding for example requires frequent stops to refill, may have efficiency of 50-60%
Large field tillage may have higher rates of 85-90% due to continuous operation, turning time reduced and minimal overlap
Second, look up in Table 4 & Table 5, typical operating speeds or performance rating for the machinery
Third, Calculate the hours of annual use (HAU)
If the machinery is rated in MILES PER HOUR:
HAU = 8.25 x (total acres of crop) x (number of passes)
Speed x Width x Efficiency
If machinery is rated in TONS PER HOUR:
HAU = Total Tons Harvested
Speed x Efficiency
23. Hours of Use Example Example for HAU (Miles per Hour):
18 Self propelled swather, efficiency rating of 75%, 5 miles per hour, and 300 acres of hay with 2 cuttings per year
HAU = (8.25) x (300 acres) x (2 cuttings) = ??? hours per year
(5 miles per hour) x (18) x (75% field efficiency)
Example for HAU (Tons per Hour):
PTO baler, pulled by 60 hp tractor, 300 acres of hay harvested per year, total average yield per acre from 2 cuttings is 2.5 ton, speed 6 tons per hour, efficiency is 75%.
HAU = (2.5 total tons) x (300 acres) x (2 cuttings) = ??? hours per year
(6 ton per hour) x (75% field efficiency)
24. Machinery Selection Difficult problem is selecting machinery with proper capacity
Factors:
Types, sizes, available capital, labor requirements, tillage practices, etc
Goal: purchase machine that will perform required task, within time available, at lowest possible cost
Two considerations: Size & Timliness
25. 1. Size - Field Capacity:How many acres can this piece of equipment cover in an hour? Field Capacity:
Fist step in machinery selection is to determine field capacity in acres per hour for each size available
Formula:
Field Capacity = speed (mph) x width (feet) x field efficiency (%)
8.25
Example:
15 ft swather, operating at 8 miles/hr, with field efficiency of 80% would have effective field capacity of
(8 x 15 x 80%)/8.25 = 11.64 acres per hour
Field efficiency is to recognize that machine is not used 100% of it maximum capacity due to:
Overlap, turning, adjusting, lubricating, handling material
Seeding for example requires frequent stops to refill, may have efficiency of 50-60%
Large field tillage may have higher rates of 85-90% due to continuous operation, turning time reduced and minimal overlap
26. 1. Size - Minimum Field Capacity:How many acres must this piece of equipment cover in an hour? Minimum Field Capacity:
Next step to selecting machinery is to determine minimum field capacity (acres/hour) needed to get job done in time available
Formula:
Minimum field capacity: Acres to Cover
Hours per day x Days available
Example:
Want to swath 150 acres in 2 days and operate for 8 hours/day
150 acres/(8 hours per day x 2 days) = 9.38 acres/hour
So, swather with capacity for covering 11.64 acres/hour is sufficient to handle this constraint of 9.38 acres/hour
27. 2. Timeliness 2. Timeliness:
Many farming activities need to be performed in a fixed time period
The later they are performed, lower the yield will be
Reduction may come in form of:
Quality: ex. hay that matures too long or dries too long
Quantity: ex. grain that has too short a growing season, loss due excess maturity, or weather risks (hail, sprouting grains)
Table 6 shows the relation between planning time and the loss in yield for winter wheat
Planting too early and planning too late reduce yield
If timeliness is a factor, the decreased yields (which reduce profit), should therefore be included as a cost of using smaller equipment
Can be called a Timeliness Cost
Determining what size of equipment to purchase, and its effects on yield, can be analyzed in a partial budget
Example: Doubling size of seeder
Gains: Losses:
Sold old seeder (salvage value) Higher cost of seeder/tractor ownership
Higher yields (higher revenues)
Fewer labor and repair costs
28. Alternatives for Machinery Ownership
Most operators prefer to own
Advantages: control over use and disposal of each machine
Disadvantage: represent a large investment
Careful to control the size of investment and related operating costs
Machinery investment can be reduced by:
Operating smaller equipment
Increasing annual use (operate for more hours in year), thus lowering average ownership costs per unit of output
Keep machinery for longer period of time before trading in
Purchase used machinery
Alternatives to ownership; renting, leasing, custom hire
29. Alternatives Rental
If capital for purchasing machinery is limited or interest rates are high, renting may be preferred
Operator pays for rental fee for equipment, insurance, and maintenance, but not major repairs
Advantages:
Specialized equipment needed for few hours
Extra capacity or a replacement machine is needed for a short period of time
Operator wants to experiment with new production practice or new style of machine
30. Alternatives Leasing
Long term contract where the lessee (machine user) has control and use of a machine for a specified period of time from the lessor (machine owner; machinery dealer or leasing company)
Typically 3-5 year leases
Some allow for purchase at end of lease for specified price (capital lease)
Advantages:
Reduce amount of capital tied up in long term assets
Lease payments are tax deductible
Lease payments are typically less than loan payments (creating more cash flow)
Reliability and performance of newer equipment
Leasing may have lower after-tax cost than owning if can not utilize 179 expensing
Disadvantage:
Late payment may lead to cancellation of lease
Penalty for early lease cancellation
Do not build equity into machinery
31. Alternatives Custom Hire
Usually fixed rate per acre, hour, or ton
Usually, cheaper to use custom hire if used only for low levels of use
More expensive if custom hire used for high levels of use
See Table 7 for graph
32. Break Even Break Even point is point where it is indifferent to own of custom hire
Formula:
B-E = Total annual fixed costs
Custom rate Variable costs per unit
Example:
If ownership costs of combine are $16,820/yr, and variable costs are $5.54/acre, and it costs $21/acre to have the grain cut custom hire, break even point would be:
$16,820 = 1,088 acres
$21.00-$5.54
If machine were used for less than 1,088 acres, it is cheaper to custom hire
If the machine were used for more than 1,088 acre, It is cheaper to own the equipment
Other points to consider:
Custom hire frees up your labor to do other things