TCC 6103

CONSTRUCTION ECONOMICS
& FINANCE

Equipment Economics
 Lecture Structure
• Introduction
• Plant Acquisition Options
• Plant Selection
• Maintenance
 INTRODUCTION
• Approx.50-60% of plant used on projects are hired.
• Of recent years plant hire sector growth has been
facilitated by the hire option.
• There are different methods of acquiring
construction equipment required for a project.
These are namely: buying, renting and leasing.
• Each of these methods has advantages and
disadvantages associated with it.
 Advantages of utilizing construction
equipment
Reduce overall construction costs especially for large
contracts;
Increase the rate of output;
 Eliminate the heavy manual work by humans thus reducing
fatigue and eliminates various other hazards and health
issues;
 Maintain the planned rate of production where there is a
shortage of skilled or unskilled labor;
 Maintain the high quality standards often required by
present-day design and specifications (technical standards).
 Parameters to Consider

Before acquiring the equipment, it is

essential to explore all the options by
considering various parameters namely:
Company's cash flow;
Depreciation/Resale value;
Working capital, taxes;
Equipment utilization rates and its maintenance;
Transportation costs-(distance, geography etc.)
 Depreciation/Resale Value
• To purchase a piece of equipment, do your research, compare
different brands and models.
• Certain machines hold their value much better than other
machines in the same product category and will be worth more
when you sell it later.
• Especially if you like to cycle in new equipment over a set time
period, selecting the right machine based on annual depreciation
and performance might be the financial difference in the
rent/buy decision.
• Similarly, used equipment available on the market is typically of
a higher quality than it was in the past, especially with dealers
and manufacturers offering certified used equipment.
 Buying Option
• Buying results in direct ownership of the equipment;
• Buying is done either through cash purchase by using
company funds or through financing purchase;
• However, cash purchase can have an adverse effect
on company's cash flow as it reduces the liquid asset
thus affecting company's working capital.
• When sufficient funds are not available for
outright cash purchase, the equipment can be
acquired by finance purchasing wherein the
purchasing is done through loan arrangements
from lenders i.e. banks or other financial
institutions that includes the payment of loan
through installments along with an initial down
payment.
 Advantages
• Results in lowest cost per operating hour as compared to
renting or leasing.
• Complete control of the owner over use of the equipment
and its maintenance and replacement of equipment when it
is no more economical.
• Ensures maximized equipment life and resale value;
• Economically attractive option when there is more work
load leading to higher utilization rate of the equipment over
its useful life.
 Disadvantages
• It will lead to the risk of not getting the required return
on the capital investment if there is not enough utilization
of the equipment;
• The equipment owner has to pay the required loan
installment to the lender even when the equipment is not
operational;
• Acquisition through buying may sometimes force the
owner to use the obsolete equipment due to financial
constraints.
 Why rent?
• Decreased downtime (not working while undergoing
repairs);
• Reliable maintenance and repair (work of rental company);
• No storage crunch;
• Get up-to-date technology: The rental market is competitive
and incites rental companies to offer recent-generation
machines that get jobs done faster and more efficiently. Up-
to-date equipment usually also means compliance with
emissions regulations.
 Renting Cont’d
• Tax benefits; no property tax…
• Capital optimisation (not tied up)
• Sharper cost control (only mind about invoice);
• Caters for short-term equipment needs;
• Provides specialty performance (specialized equipment);
In these circumstances, renting of the equipment is more
beneficial than direct ownership even though the rental
charges are higher than the direct ownership charges.
• The most often recommended numeric
benchmark for when it’s time to cross
over from rental to purchase is when
the equipment is needed and used at
least 60% and above of the time.
.
Plant and Equipment Acquisition Cont’d

Alternative decision to purchase has important

financial consequences:
i) Capital lockup in case of purchase;
ii) Operate/hire out at an economic utilization
level to produce a profitable rate of return
on investment
Further Considerations for Owning Plant

When examining need to own plant, consider the

following:
 Will the item of plant generate sufficient turnover to
provide an adequate rate of return on the capital
employed?
 One time job - hire;
 Is ownership of the plant, rather than obtaining it by some
other method, absolutely necessary for the business?
 Use on multiple sites - purchasing or leasing
 Equipment Financing
Once a firm has decided to purchase rather
than hire, the following methods of arranging finances are
available:
Cash or outright purchase
Hire purchase
Leasing (long term rental - over 12 mths)
 Cash or Outright Purchase
Equipment paid for immediately at time of purchase;
Possible on availability of sufficient funds .
Possible Sources of funding:
i)Profits built up from previous tradings
ii)From shareholders;
iii)Bank loans etc
iv)Also by nature of contract-it may include
monies that the contractor is permitted to
purchase equipment at start of a project.
 Hire Purchase
Involves a contract btn purchaser and supplier of
finance in which the purchaser pays specified
rentals during the contract period;
At the end of contract period, title of asset is
transferred to purchaser for previously agreed
sum;
Suitable when the contractor requires the
equipment for a project task of longer durations.
 Hire Purchase Cont’d

The repair and maintenance cost of the equipment

to be paid either by the user or owner of the
equipment as stated in the hire contract;

Need for large capital sums is avoided;

 Leasing
A lease is defined as a contract whereby, in return
for payment of specified rentals, the lessee (user of
equipment) obtains the use of a capital asset owned
by another party (lessor)-leasing company(owner).
Fundamentally different from either outright or hire
purchase in that the title theoretically never passes
to the lessee (user).
When It’s Best to Lease
 Leasing can be an attractive option if
you use the equipment frequently but don’t
have the resources to purchase equipment
outright or make an adequate down payment.
 However, leasing carries higher interest
rates and contractors usually are responsible
for the insurance and personal property taxes
on the equipment being leased. 
 Types of Leasing
Several types of lease exist but two forms are appropriate
for plant acquisition:
i)Finance lease, ii)Operating lease
The finance lease is generally offered by a financial
institution (usually a bank or a finance company) and
the equipment is leased to the lessee.
Lease period may extend up to the operating life of the
equipment.
 Finance Leasing Cont’d
• Divided into: Primary period, 3-5yrs; Rentals set
to cover all related costs of the lessor
(overheads, interest charges, servicing + profit);
• Secondary (continuation) period-fixed time
interval extended to suit the lessee’s needs and
may require a nominal rental.
 Finance Leasing Cont’d
• At the end of the lease, the asset is sold by the lessor but
not directly to the lessee, as specified in the contract;
• Often lessor has no direct interest in the leased asset, it is
usual that the contract cannot be cancelled until the lessor
has realized the investment at the end of primary period;
• Lessee has full use of asset as though it were owned;
• The finance lease is stated on lessee's balance sheet.
 Operating Lease
• The lessors in the case of operating lease are normally
manufacturers or suppliers of the asset, whose
purpose is to assist in the marketing of the item;
• Charges are frequently lower than those required by a
finance lease because the type of asset involved either
would have a good secondhand value or be tied to a
lucrative service agreement or supply of spare parts;
 Operating Lease Cont’d
• Appropriate for large and technically sophisticated plant
items e.g. haulage trucks, cranes, where manufacturers
have skilled personnel for maintenance/services;
• Usually lessee returns the equipment to lessor at the end
of lease period;
• Unlike finance lease, operating lease is not stated on
lessee's balance sheet and is often referred to as off-
balance-sheet financing.
PLANT SELECTION
Factors behind selection of construction
equipment
 Introduction

 Good project management in construction must vigorously

pursue the efficient utilization of labor, material and
equipment.
 The use of new equipment and innovative methods has made
possible great changes in construction technologies in recent
decades.
 The selection of the appropriate type and size of construction
equipment often affects the required amount of time and effort
and thus the job-site productivity of a project.
 Equipment Selection Criteria
• Selection of the right piece of equipment, like the right
man for the job, affects field productivity which directly
influences profitability.
• Using a machine that does not have enough capacity will
slow down productivity.
• Using a machine with too large capacity might increase
productivity to some extent, but will ultimately
negatively affect profitability, because of the cost of
operation of the oversized machine.
 Equipment Selection Cont’d
• It is therefore important for site managers and
construction planners to be familiar with the
characteristics of the major types of equipment
most commonly used in construction.
• As such, there are a number of basic
considerations for selecting the right piece of
equipment for any given task.
Factors Behind the Selection of Construction Equipment

 Economic Considerations
 Company-Specific
 Site-Specific
 Equipment-Specific
 Client and Project-Specific
 Manufacturer-Specific
 Labour Consideration
 Economic Considerations

• The economic considerations such as owning

costs, operating labour costs and operating fuel
costs of equipment are most important in
selection of equipment;
• Desired productivity (Hourly amount of work to
be done and how fast it has to be done);
• Besides, the resale value, the replacement costs of
existing equipment, and the salvage value
associated with the equipment are also important. 
• Equipment needs are further influenced by the
complexity and uniqueness of a specific work
activity.
• The type and condition of the working surface
and the distance to be travelled affect the choice
of tires or tracks
 Company-Specific

• Equipment selection is typically company-specific

and directly influenced by specific project and
financial considerations;
• The selection of equipment by a company may be
governed by its policy on “owning” or “renting”.
• While emphasis on “owning” may result in
purchase of equipment keeping in mind the future
requirement of projects, the emphasis on “renting”
may lead to putting too much focus on short-term
benefits.
 Site-Specific

• Site conditions - both ground conditions as well as

climatic conditions-may affect the equipment
selection decision.
• For example, the soil and profile of a site may dictate
whether to go for a crawler-mounted equipment or a
wheel-mounted equipment.
• If there is a power line at or in the vicinity of site, one
may go for a fixed-base kind of equipment rather than
a mobile kind of equipment.
 Equipment-Specific

Construction equipment come with high price tags.

While it may be tempting to go for the equipment
with low initial price, it is preferable to opt for
standard equipment;
Such equipment are manufactured in large numbers
by the manufacturers, and their spare parts are
easily available, proper and timely service available
which would ensure minimum downtime.
 Besides, they can also fetch good salvage money at
the time of their disposal.
 Client and Project-Specific

The owner/client in a certain project may have

certain preferences that are not in line with the
construction company's preferred policies as far as
equipment procurement is concerned.
The schedule, quality and safety requirements
demanded of a particular project may in some
cases force the company to yield to the demands
of the client.
 Manufacturer-Specific
A construction company may prefer to buy
equipment from the same manufacturer again and
again, and that too from a specific dealer.
This may be to bring in uniformity in the
equipment fleet possessed by the company or
because the company is familiar with the working
style of the manufacturer and the dealer.
 Labour Consideration

Shortage of manpower in some situations may

lead to a decision in favour of procuring
equipment that is highly automated.
Further, the selection of equipment may be
governed by the availability or non-availability of
trained manpower.
END