Issue Identification and Appraisal
Having moved into the final stages of the mentoring course, the task of reviewing the Engineering Economy book has arrived. And have to admit that this has never been a favourite subject, and so the final four blogs (21 thru’ 24) will be dedicated to knowledge advancement in this learning process.
As a starting point, the first blog will look at options available when in the market for a new piece of equipment. This applies to all types of equipment and in some circumstances also applies to business and personal circumstances. So, for the blog, let’s assume a Company, “ABC” is in the market for a new vehicle.
This week’s problem statement, “What is the most economical option for obtaining ABC’s new vehicle?”
As this will be a new vehicle, Company ABC have already decided that the use of a second-hand vehicle is not an option, there are three feasible alternatives, which are:
Develop the Outcomes for each
Purchase – Determined by the negotiated sale price of the vehicle, amount of down-payment/trade-in, interest rate being charged.
Lease – Usually built around several factor’s; the vehicles sales price, the residual value of the vehicle when returned, the interest rate being charged. Usually there is an upfront payment made at the time of signing the lease which will also affect the total monthly lease cost.
Rent – Very similar to leasing but usually over shorter time period with options to extend. Depending on equipment required, is a good option for construction equipment whereby it may only be required for a short time in the project duration, and no need to have protracted costs for duration of project. This is probably a more costlier option for a vehicle purchase.
The criteria selection for evaluation of the feasible alternatives is:
- Truck for construction business, to be used for hauling tools, equipment and staff (4/6 people).
- The negotiated sales price of the vehicle is $ 50,000.
- The ownership term is to be 5 years (60 months).
- Purchase option down-payment is $17,500 (includes $12,500 trade-in of existing vehicle, plus $5,000).
- Lease up-front payment is $17,500 (again it includes the above trade-in/additional payment).
- APR interest rate is 12%
- Residual value of vehicle after 5 years will be 37% of the negotiated sales price.
- This exercise does not include for any applicable state taxes that are charged on new vehicle purchases.
- Assumption; All maintenance, insurances, road taxes are equivalent across all three options.
Analysis and Comparison of the Alternatives
Sales Price = $50,000 – Down-payment $17,500 = Loan requirement $32,500. Therefore, the amount payable for a loan of $32,500 over 5 years would be 32,500 x 5 x 12% = $19,500. Total Cost: $50,000 + $19,500 = $69,500. Monthly cost = $1,158.33
Sales Price = $50,000 – Down-payment $17,500 = $32,500 / Residual value after 5 years = $50,000 x 45% = $18,500. Lease amount = $32,500(A/P,1%,60) – $18,500(A/F,1%,60) = $32,500(0.0222) – $18,500(0.0122) = $721.50 – $225.70 = $495.80 per month (Total cost over the 5 years = $17,500 + 60 x $495.80 = $47,248)
There is very little in the way of formulas available to develop vehicle rental rates, so the principle applied here is: Determine the overall cost of the vehicle (purchase, loan funding) and divide the total by the number of months required. It is assumed that the Rental Company would secure better finance deals and even better negotiated sales price for the vehicle, so this is where they would make their money.
Value of Rental $50,000. Therefore, the amount payable for a loan of $50,000 over 5 years would be 50,000 x 5 x 12% = $30,000. Total Cost: $50,000 + $30,000 = $80,000. Monthly cost = $1,333.33 (depending on the Company renting the vehicle these costs could be higher)
As expected, the Rental cost is highest option, with the outright purchase being next, and the lease costs being somewhat attractive.
Selection of Preferred Alternative
The preferred alternative in this instance is for Company ABC to take the Lease option to secure their new vehicle.
Monitoring Post Evaluation Performance
Post decision making for the purchase of a vehicle would be a difficult decision to undo, but I’d expect that Company ABC periodically check the leasing market to determine if the deal they received is indeed the best available deal.
- Mortgage Choice. (2017). How to calculate rental yield. Retrieved October 20, 2017, from https://www.mortgagechoice.com.au/home-loans/home-buying-advice/tips-and-tools/what-is-rental-yield.aspx
- Rent, buy or lease? the crucial answer to your next equipment purchase | equipment world | construction equipment, news and information | heavy construction equipment. (2013, May 1). Retrieved from https://www.equipmentworld.com/rent-buy-or-lease/
- Sullivan, W. G., Wicks, E. M., & Koelling, C. P. (2012).Engineering economy (international edition) (15th ed.). Harlow, England: Pearson.