Construction Methods - Chapter17.pdf - po ang - Januszek66

ConstructionEconomics

17–1INTRODUCTION

Ashasbeennotedonanumberofoccasions,constructioncontractingisahighlycompet-

itivebusiness.Therefore,thefinancialmanagementofaconstructioncompanyisequally

asimportanttocompanysuccessasisitstechnicalmanagement.Asamatteroffact,many

successfulconstructorshaveevolvedfromabackgroundofbusinessandfinancerather

thanfromconstructionitself.However,thereislittledoubtthatastrongtechnicalbasesup-

portedbybusinessskillsandmanagementabilityprovidesthebestfoundationforsuccess

asaconstructionprofessional.

Acompletediscussionofthemanyfacetsofconstructioneconomicsisbeyondthe

scopeofthisbook.Rather,thepurposeofthischapteristointroducethereadertotheter-

minologyandbasicprinciplesinvolvedindeterminingtheowningandoperatingcostsof

constructionplantandequipment,analyzingthefeasibilityofrentingorleasingratherthan

purchasingequipment,andthefinancialmanagementofconstructionprojects.

17–2TIMEVALUEOFMONEY

Everyoneisawarethattheamountofmoneyheldinasavingsaccountwillincreasewith

timeifinterestpaymentsareallowedtoremainondeposit(compound)intheaccount.The

valueofasumofmoneyleftondepositafteranyperiodoftimemaybecalculatedusing

Equation17–1.

P (1 "

(17–1)

where F

% valueatendof n periods(futurevalue)

% presentvalue

% interestrateperperiod

% numberofperiods

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CHAPTER17

isoftencalledthe single-paymentcompoundinterestfactor.

Equation17–1canbesolvedtofindthepresentvalue(presentworth)ofsomefuture

amount,resultinginEquation17–2.

Theexpression(1 "

(17–2)

iscalledthe single-paymentpresentworthfactor. Expres-

sionshavealsobeendevelopedthatyieldthevalueofaseriesofequalperiodicpayments

attheendofanynumberofperiods (uniformseriescompoundamountfactor), thepresent

worthofsuchaseries (uniformseriespresentworthfactor), theperiodicpaymentrequired

toaccumulateadesiredamountatsomefuturedate (sinkingfundfactor), andtheannual

costtorecoveraninvestment,includingthepaymentofinterest,overagivenperiodoftime

(capitalrecoveryfactor). Otherexpressionshavebeendevelopedtofindthepresentandfu-

tureworthofgradient(nonuniform)seriesofpayments.

Theseequationsformthebasisofatypeofeconomicanalysiscommonlycalled eng-

ineeringeconomy. Themethodsofengineeringeconomyarewidelyusedtoanalyzethe

economicfeasibilityofproposedprojects,tocomparealternativeinvestments,andtode-

terminetherateofreturnonaninvestment.However,becauseoftheircomplexityandthe

difficultyofaccountingfortheeffectsofinflationandtaxes,thesetechniqueshavenotbeen

widelyusedwithintheconstructionindustry.Constructionequipmentowningcosts,forex-

ample,areusuallydeterminedbythemethodsdescribedinthefollowingsectionratherthan

byemployingengineeringeconomytechniques.Apresentworthanalysis,however,isvery

helpfulwhencomparingthecostofdifferentalternatives.Thisisillustratedbythe

rent–lease–buyanalysisdescribedinSection17–4.

Theexpression1/(1 "

17–3EQUIPMENTCOST

ElementsofEquipmentCost

Inearlierchapters,wehavediscussedtheproperapplicationofthemajoritemsofcon-

structionequipmentandsomemethodsforestimatingequipment’shourlyproduction.We

thendividedtheequipment’shourlycostbyitshourlyproductiontoobtainthecostperunit

ofproduction.However,uptothispointwehavesimplyassumedthatweknewthehourly

costofoperationoftheequipment.Inthissectionweconsidermethodsfordeterminingthe

hourlycostofoperationofanitemofequipment.Althoughtheproceduresexplainedinthis

sectionarethosecommonlyemployedintheconstructionindustry,theyarenottheonly

possiblemethods.

Infollowingtheproceduresofthissection,youwillnotethatitisnecessarytoesti-

matemanyfactors,suchasfuelconsumption,tirelife,andsoon.Thebestbasisforesti-

matingsuchfactorsistheuseofhistoricaldata,preferablythoserecordedbyyour

constructioncompanyoperatingsimilarequipmentundersimilarconditions.Ifsuchdata

arenotavailable,consulttheequipmentmanufacturerforrecommendations.

Equipment owningandoperatingcosts (frequentlyreferredtoas O&Ocosts ),asthe

nameimplies,arecomposedofowningcostsandoperatingcosts.Owningcostsarefixed

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CONSTRUCTIONECONOMICS

coststhatareincurredeachyearwhethertheequipmentisoperatedornot.Operatingcosts,

however,areincurredonlywhentheequipmentisused.

OwningCosts

Owningcosts aremadeupofthefollowingprincipalelements:

•Depreciation.

•Investment(orinterest)cost.

•Insurancecost.

•Taxes.

•Storagecost.

Methodsforcalculatingeachoftheseitemsaredescribednext.

Depreciation

Depreciation representsthedeclineinmarketvalueofanitemofequipmentduetoage,

wear,deterioration,andobsolescence.Inaccountingforequipmentcosts,however,depre-

ciationisusedfortwoseparatepurposes:(1)evaluatingtaxliability,and(2)determining

thedepreciationcomponentofthehourlyequipmentcost.Notethatitispossible(andle-

gal)tousedifferentdepreciationschedulesforthesetwopurposes.Fortaxpurposesmany

equipmentownersdepreciateequipmentasrapidlyaspossibletoobtainthemaximumre-

ductionintaxliabilityduringthefirstfewyearsofequipmentlife.However,theresultis

simplytheshiftingoftaxliabilitybetweentaxyears,becausecurrenttaxrulesoftheU.S.

InternalRevenueService(IRS)treatanygain(amountreceivedinexcessoftheequip-

ment’sdepreciatedorbookvalue)onthesaleofequipmentasordinaryincome.Thede-

preciationmethodsexplainedinthefollowingpagesarethosecommonlyusedinthe

constructionequipmentindustry.Readersfamiliarwiththesubjectofengineeringeco-

nomicsshouldrecognizethatthemethodsofengineeringeconomymayalsobeemployed.

Whenthemethodsofengineeringeconomicsareused,thedepreciationandinvestment

componentsofequipmentowningcostswillbecalculatedtogetherasasinglecostfactor.

Incalculatingdepreciation,theinitialcostofanitemofequipmentshouldbethefullde-

liveredprice,includingtransportation,taxes,andinitialassemblyandservicing.Forrubber-

tiredequipment,thevalueoftiresshouldbesubtractedfromtheamounttobedepreciated

becausetirecostwillbecomputedseparatelyasanelementofoperatingcost.Equipmentsal-

vagevalueshouldbeestimatedasrealisticallyaspossiblebasedonhistoricaldata.

Theequipmentlifeusedincalculatingdepreciationshouldcorrespondtotheequipment’s

expectedeconomicorusefullife.TheIRSguidelinelifeforgeneralconstructionequipmentis

currently5years,sothisdepreciationperiodiswidelyusedbytheconstructionindustry.

Themostcommonlyuseddepreciationmethodsarethestraight-linemethod,the

sum-of-the-years’-digitsmethod, thedouble-decliningbalancemethod,andIRS-

prescribedmethods.Proceduresforapplyingeachofthesemethodsareexplainedbelow.

Straight-LineMethod. The straight-linemethod ofdepreciationproducesauniformde-

preciationforeachyearofequipmentlife.Annualdepreciationisthuscalculatedasthe

amounttobedepreciateddividedbytheequipmentlifeinyears(Equation17–3).The

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CHAPTER17

amounttobedepreciatedconsistsoftheequipment’sinitialcostlesssalvagevalue(andless

tirecostforrubber-tiredequipment).

% Cost # Salvage 1 # tires 2

(17–3)

where N % equipmentlife(years)

n % yearoflife(1,2,3,etc.)

EXAMPLE17–1

Usingthestraight-linemethodofdepreciation,findtheannualdepreciationandbookvalue

attheendofeachyearforatrackloaderhavinganinitialcostof$50,000,asalvagevalue

of$5000,andanexpectedlifeof5years.

SOLUTION

D 1,2,3,4,5 % 50,000 # 5000

% $9000

BookValue

Year Depreciation (EndofPeriod)

0 $50,000

$9,000 41,000

9 ,000 32,000

9 ,000 23,000

9 ,000 14,000

9 ,000 5,000

Sum-of-the-Years’-DigitsMethod. The sum-of-the-years’-digitsmethod ofdepreciation

producesanonuniformdepreciationwhichisthehighestinthefirstyearoflifeandgradu-

allydecreasesthereafter.Theamounttobedepreciatedisthesameasthatusedinthe

straight-linemethod.Thedepreciationforaparticularyeariscalculatedbymultiplyingthe

amounttobedepreciatedbyadepreciationfactor(Equation17–4).Thedenominatorofthe

depreciationfactoristhesumoftheyears’digitsforthedepreciationperiod(or1 " 2 " 3

" 4 " 5 % 15fora5-yearlife).Thenumeratorofthedepreciationfactorissimplythepar-

ticularyeardigittakenin inverse order(i.e.,5 # 4 # 3 # 2 # 1).Thusforthefirstyearof

a5-yearlife,5wouldbeusedasthenumerator.

% Yeardigit

Sumofyears , digits $ Amounttobedepreciated

(17–4)

TheprocedureisillustratedinExample17–2.

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CONSTRUCTIONECONOMICS

EXAMPLE17–2

FortheloaderofExample17–1,findtheannualdepreciationandbookvalueattheendof

eachyearusingthesum-of-the-years’-digitsmethod.

SOLUTION

UsingEquation17–4:

15 $

1 50,000 # 5000 2

% 15,000

15 $

1 50,000 # 5000 2

% 12,000

15 $

1 50,000 # 5000 2

% 9,000

15 $

1 50,000 # 5000 2

% 6,000

15 $

1 50,000 # 5000 2

% 3,000

BookValue

Year Depreciation (EndofPeriod)

0 $50,000

$15,000 35,000

12,000 23,000

9 ,000 14,000

6 ,000 8,000

3 ,000 5,000

Double-Declining-BalanceMethod. The double-declining-balancemethod ofdeprecia-

tion,likethesum-of-the-years’-digitsmethod,producesitsmaximumdepreciationinthe

firstyearoflife.However,inusingthedouble-declining-balancemethod,thedepreciation

foraparticularyearisfoundbymultiplyingadepreciationfactorbytheequipment’s book

valueatthebeginningoftheyear (Equation17–5).Theannualdepreciationfactorisfound

bydividing2(or200%)bytheequipmentlifeinyears.Thusfora5-yearlife,theannualde-

preciationfactoris0.40(or40%).Unliketheothertwodepreciationmethods,thedouble-

declining-balancemethoddoesnotautomaticallyreducetheequipment’sbookvaluetoits

salvagevalueattheendofthedepreciationperiod.Sincethebookvalueofequipmentisnot

permittedtogobelowtheequipment’ssalvagevalue,caremustbetakenwhenperforming

thedepreciationcalculationstostopdepreciationwhenthesalvagevalueisreached.Thecor-

rectprocedureisasfollows:

$ Bookvalueatbeginningofyear

(17–5)

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