DCC Farm

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 - property�s 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 manager�s 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