MF2244 Farm Machinery Operation Cost Calculations
Farm MachineryOperation CostCalculationsTerry KastensExtension Agricultural EconomistKansas State UniversityKansas State University Agricultural Experiment Station and Cooperative Extension Service
ContentsValuing Machinery Over Time4TablesAnalysis Time Period4Current List Price4Table 1. Producer Price Index,U.S. Average, All Commodities5Producer Price Index4Table 2. Factors for CalculatingRemaining Value Percentagesby Machinery Class6Table 3. Cross and Perry AdjustmentFactors for Selected Machinery Classesand Manufacturers8Remaining Value Percentage,Economic Depreciation, andMarket ValuePurchase Price and Selling PriceAnnual Operating Costs61011Field Efficiency11Fuel and Lubrication11Labor11Repair and Maintenance13Timeliness15Property Taxes, Insurance, and Shelter16Income Tax and Finance16Marginal Tax Rates16Cost of Capital16Net Present Value17Amortized Annual Cash Flow18Finance18Income Tax Depreciation20Income Tax Savings21Net Cash Inflows for ComputingNet Present Value21Using the Machinery CostAnalysis Results to Make Decisions21Example 1: Costs for a NewCase-IH Combine across ThreeUsage Rates22Example 2: Costs for a NewCase-IH Combine across ThreeInflation Rates22Example 3: Costs for a New 8-RowPlanter with and without Section179 Expensing Deduction23Conclusion23References23Table 4. Field Efficiency, Field Speed,and Repair and Maintenance Factorsfor Field Operations12Table 5. Average Energy and FuelRequirements for Selected MachineryOperations14FiguresFigure 1. Annual Inflation Based onProducer Price Index, 1950-19965Figure 2. Remaining Value as a Percentof Current List Price by Age, for SeveralMachinery Classes7Figure 3. Remaining Value as a Percentof Current List Price for Combines withAnnual Usage of 200 Hours9Figure 4. Annual Depreciation as a Percentof Previous Year’s Price for Combines withAnnual Usage of 200 Hours9Figure 5. Remaining Value as a Percentof Current List Price for a Deere Combineacross Various Annual Usage Rates9Figure 6. Remaining Value as a Percentof Current List Price for 175 hp Tractorswith Annual Usage of 500 Hours10Figure 7. Annual Depreciation as aPercent of Last Year’s Price for 175 hpTractors with Annual Usage of 500 Hours10Figure 8. Accumulated Repairs as aPercent of Current List Price for a TandemDisk across Three Annual Usage Rates13Figure 9. Cost per Acre for a Case-IHCombine, at Three Annual Usage Rates22Figure 10. Cost per Acre for a Case-IHCombine at Three Annual Inflation Rates23Figure 11. Cost per Acre for an 8-Row Planter,with and without Section 179 Deduction231
Abbreviations Used in this PublicationACAGEAHAPHARMASAEBTBASISCFCLPCOCdep1, DFCFNHNPVPPIPURRAFRF1, RF2RMRVPSESEC179SELLT1T2TBASISTDEPRTIS2Allis Chalmers GleanerMachine’s age in yearsAccumulated Hours on a MachineAcres per HourAccumulated Repair and Maintenance ChargesAmerican Society of Agricultural EngineersBeginning Tax Basis at the Time of PurchaseCash FlowCurrent List PriceCost of Capital RateDepreciation FactorsTax Deductable Financing Cash FlowEstimated Useful LifeField Efficiency PercentageFuel and Lubrication ChargesField SpeedSelling Price Less Tax BasisAverage Hours per Year of machine usage since it was newInflation Adjusted Amortized Annual Cash FlowInternational HarvesterIncome Tax SavingsAnnual Labor ChargesModified Accelerated Cost Recovery SystemMassey FergusonMarket ValueMachine WidthNondeductible Financing Cash FlowNew HollandNet Present ValueProducer Price IndexPurchase PriceRepair Adjustment FactorRepair FactorsRepair and Maintenance Charge for a Specific YearRemaining Value PercentageNet Self-employment Tax RateSection 179 Expense DeductionSelling PriceFederal and State Income Tax RateFederal and State Income Tax Rate, Including Self-employment Tax RateRemaining Tax Basis in any Given YearTax Depreciation in a Given YearProperty Taxes, Insurance, and Shelter
Machinery operating and ownership costs areoften more than half of total crop production costsfor Kansas producers and substantially affect farmprofitability. Besides affecting fundamental machinery buying and trading decisions, machinery costsaffect profit-maximizing crop and rotation selection, thus long-run farm profitability. Understanding machinery costs becomes especially crucialwhen considering alternative cropping systems,particularly when less tillage is involved. In short,machinery costs enter farm management in threeareas: 1) minimizing costs of production,2) selecting the profit-maximizing crop mix, and3) considering structural or technological changes,such as farm expansion or contraction, or alternative tillage systems.Minimizing the machinery portion of production costs requires routine assessment of the benefits and costs associated with owning, leasing, orrenting machinery. These must regularly be compared with hiring machinery operations (customfarming), which is often a plausible alternative. Toassist farm managers in machinery decisions, thisbulletin develops a framework for calculating andanalyzing the various components of a machine’sexpected annual costs: repairs and maintenance;gas, fuel, and oil; operating labor; insurance andtaxes; depreciation; and opportunity cost on fundsused.For crop enterprise selection, machinery costsmust be assigned to specific crops or crop sequences. Actual historical machine costs can provide abasis for such assignments but may be difficult toobtain. That is, some costs associated with machinery operations are difficult to allocate to the usageof specific machines. However, because producerscan identify each machine and the number of itsoperations associated with a crop, a framework forcalculating a machine’s expected costs can assist indeveloping crop-specific machinery costs.Machinery costs are especially important whenconsidering structural or technological changes. Forexample, recently acquired rented land, requiringadditional machinery, may be unavailable in thefuture. An experiment in no-till farming, requiringless machinery, may turn out to be unprofitable.In such cases, inherent risks may cause a producer to make the change while retaining thepre-existing machinery line. Understandinghow machinery costs are affected by intensity ofmachine use is crucial to such decisions. Thus,methods for analyzing machinery costs shouldbe detailed enough to deal with such issues.Machinery investment analysis is morecomplex than dealing with annual cash inputs,such as seed or fertilizer, because benefits andcosts accrue over a number of years. That is,each machine operation is associated with astream of cash outflows/inflows over time.Income tax rates, interest rates, depreciationrates, and inflation rates affect the cash flows.The goal in machinery cost analysis is to provide a framework for combining net cash flowsfor several machine operations, or machineryservices, into a single annual value. In that way,the annual machinery costs associated with onecropping/tillage scenario can be directly compared with those from another scenario, or withcustom farming charges.Comparison of simulated machinery costswith custom farming charges is not only important because custom farming is a competing source of machinery operations, but alsobecause custom rates can be used to validatesimulated costs. This follows because customrates are market-based. Further, because theyare readily available, custom rates provide aninexpensive proxy for actual machinery costsin the absence of more reliable information.1Nonetheless, custom rates provide a poor proxyin analyzing structural or technological farmchanges such as those already noted. Thesesituations demand the more detailed machineryownership costs analysis framework developedhere.Fundamental to understanding machineryownership costs is an understanding of howmachinery is valued over time. This topic iscovered in the first section of this bulletin. Thesecond section covers traditional annual operating costs such as fuel and labor. The thirdsection introduces income taxes and finance.One readily available publication providing custom farming rates in Kansas on a regional basis is “Custom Rates”, published annually by Kansas Dept. of Agriculture, Kansas Agricultural Statistics (address: Agricultural Statistician, P.O. Box 3534, Topeka, Kansas, 66601-3534).13
To expedite understanding, concepts are presentedin both words and in mathematical formulas withnumerical examples. The order of presentationfacilitates the mathematical development of theformulas as they would need to evolve if placed ina computer spreadsheet.Valuing MachineryOver TimeAnalysis Time PeriodA machinery or machine operation cost analysis takes place at a specific point in time. However,because it regularly involves capital investment (asin purchased machines), the analysis covers somefixed amount of time into the future, for example 10years.2 We assume this analysis is occurring aroundthe end of 1996, while planning for machine operations in 1997 and beyond. Any machinery considered purchased is assumed purchased in 1996 (year0). However, it is not used until 1997 (year 1). A10-year analysis (including 10 harvests) would endfollowing the fall harvest in 2006 (year 10). Variables are subscripted as needed with either an n(1996, 1997, ) or a k (0,1, ) to facilitate trackingin a spreadsheet setting. The symbols begin and endrefer to beginning and ending years in an analysis,respectively (depending upon whether n or k isused to denote years, begin 1996 or begin 0; likewise, a 10-year study is associated with either end 2006 or end 10).Current List PriceA new machine rarely sells at its list price. Rather, it sells around 80 to 90 percent of list (Bowers,1994). Because machinery list prices are more readilyavailable than prices paid, research has often beenconducted on that basis, leading certain formulas todepend on list price. A current list price needs to beestablished whether the machine is new or used. Fora new machine today, current list price is today’s listprice. For a used machine today, current list price isthe value at which an identical machine would belisted today, if it were new.One way to establish the current list price (in1996) for a 1991 John Deere Model 9600 combine isto observe the list price at a John Deere dealer today (1996) for a 1996 John Deere Model 9600 combine.3 That value is the current list price for the 1991used combine. However, the 1996 combine oftencontains technologically-improved features overthe 1991 model. Thus, it may not be identical to the1991 model. Furthermore, models manufactured inthe past may have been discontinued. In such cases,using today’s list price to represent the current listprice of a used machine may be inappropriate.A second, and often more appropriate methodfor establishing current list price (in 1996) for the1991 John Deere combine is to directly adjust theoriginal list price of the combine in 1991 by a suitable measure of price inflation occurring between1991 and 1996. A commonly used measure of priceinflation for agriculture is the producer price index.Producer Price Index4Table 1 provides historical producer price index(PPI) values. It also provides annual inflation rates,which can be computed from successive PPI valuesaccording to: inflation (i) (PPIn PPIn-1) - 1. Thecurrent list price in year n, CLPn, is computed fromthe current list price in year m as follows.Equation 1CLPn CLPm PPInPPImSuppose the original list price (when new) forthe 1991 combine discussed earlier was known to be 100,000, i.e., CLP1991 100,000. Then the currentlist price (in 1996) for the same combine is CLP1996 CLP1991 PPI1996 PPI1991. Using values in Table 1,CLP1996 100,000 127.8 116.5 109,700.2There are no limitations here. Costs associated with a pre-existing machine can be analyzed as readily as a newly acquired machine. The end ofthe analysis time period does not have to correspond with an expected machine disposal date. Nonetheless, as will be shown later, certain incometax implications do depend on whether or not a machine is actually bought or sold during the analysis time period.3References to particular brands in this paper are for educational purposes only and do not reflect an endorsement by the author.4Economists refer to observed prices as nominal prices and observed prices that have been adjusted for inflation as real prices. In this publicationprices are nominal prices. When required, adjustments for inflation are made explicit by the formulas.4
Table 1. Producer Price Index, U.S. Average, All .02455Source: Federal Reserve Bank of St. Louis FRED database (http://www.stls.frb.org/fred)Notes:1982 100, 1996 based on monthly indices through August, 1996.Years 1997-2007 assume same annual inflation rate estimated for 1996.Because decisions based on machinery costanalysis are always forward-looking, expectationsfor future inflation rates are required. As an indication of inflation level possibilities, Figure 1 depictsPPI-based inflation from 1950 through 1996 (1996value based on first 8 months). Most years, inflationFigure 1.Annual Inflation Based on Producer Price Index, 1950–19960.2Percent (decimal form)0.150.10.050levels were in the 0 percent to 5 percent range, witha few years displaying negative inflation (deflation). Two inflation spikes during the 1970s standout, along with the precipitous decline in the early1980s. Historically, the preceding year’s inflationhas been a more reliable indicator of the currentyear’s inflation than has been a longer-term multiyear average. So, PPI values in Table 1 for futureyears assume the same inflation rate computedfor 1996 (i 0.02455, or around 2.5 percent). Thus,Equation 1 is also used to estimate current list pricein future years. For example, CLP2006 CLP1996 PPI2006 PPI1996 109,700 162.9 127.8 139,829. Because annual inflation rates are assumed to be the same over the 10 years following 1996, the current list price in 1997 also maybe determined with the formula CLP2006 CLP1996 (1 i)10 109,700 (1.02455)10 109,700 1.2745 139,810, which is the same as 139,829except for rounding errors.-0.051950 1954 1958 1962 1966 1970 1974 1978 1982 1986 1990 19945
Remaining Value Percentage, EconomicDepreciation, and Market ValueRemaining value percentage (RVP) is thepercent (in decimal form) that a machine’s marketvalue is of its current list price (both evaluated inthe same year). RVP helps determine a machine’seconomic depreciation, which is the amount ofmarket value lost each year due to age, wear, andobsolescence (not to be confused with tax depreciation). For a particular class of machinery, remaining value percentage is often assumed to be determined by its age and not its rate of use, using aconstant rate of market value depreciation. Bowersuses the following formula developed by the American Society of Agricultural Engineers (ASAE):Equation 2RVPn RVP1n dep1 dep2AGEn,if AGEn 1, and 0.85 if AGEn 1;where RVPn is RVP in year n (the 1 following RVPdistinguishes the ASAE formula from an alternativepresented later), AGEn is a machine’s age in yearsin year n. Depreciation factors for different machinery classes, dep1 and dep2, are in Table 2. Equation2 states that with 0 inflation a machine depreciatesannually at the rate of (1-dep2). That is, each year itis worth dep2 as much as it was the year before.Figure 2 graphically shows RVP1 values computed from Equation 2 for several classes of machinery. Planters and tillage equipment depreciatemore slowly than other classes, and at the end of 20years, are still worth 29 percent of their current listprices. On the other hand, balers are worth only 12percent of their current list prices at the end of 20years. Combines and tractors are in between.Factors dep1 and dep2 in Equation 2 werecomputed with and are designed to be used withmachinery that is at least 1 year old. Thus, a conditional statement follows the formula in Equation 2.Without that conditional statement, because dep20 1, new machines would be estimated to cost dep1of current list price. The dep1 values in Table 2 aretoo low to appropriately value new machines. Instead, new machines are assumed to cost 85 percentof their list prices.Market value in year n, MVn, is the remainingvalue percentage times current list price:Equation 3MVn CLPn RVPnEconomic depreciation is the change in marketvalue across any 2 years, or MVn-MVn-1. Becausecurrent list price is affected by inflation, and because remaining value percentage is a measure ofeconomic depreciation, Equation 3 shows that bothinflation and economic depreciation affect current market value of machinery. If inflation is highenough to offset economic depreciation, causingCLP to rise rapidly over years, a used machine maysell for more than when it was new.Continuing with the combine example, the 1996remaining value percentage is RVP11996 dep1 dep2(1996-1991), or 0.65 0.935 0.4522. Inserting the 109,700 value for CLP1996 computed earlier, market value in 1996 is MV1996 109,700 0.4522 49,606.Equation 2 depicts economic depreciation as afixed cost relating to age. However, because wearis a function of rate of use, if rate of use variesacross machines and years, depreciation may haveboth variable and fixed cost components. For someTable 2. Factors for Calculating Remaining Value Percentages byMachinery Class.Machinery ClassWindrowersForagePlanters/Factor 6Source: Machinery Replacement Strategies, by Wendell Bowers, Deere and Company,1994, p.9Notes:Factors used to calculate remaining value from age: RVP dep1 dep2AGE.When age is 0 RVP is assumed to be 0.85.6
Figure 2.Percent (decimal form)0.7Remaining Value as a Percent of Current List Priceby Age, for Several Machinery Classes0.6Equation 4RVPn RVP2n (a b (AGEn)c d (HPYn)e)f,if AGEn 1, and 0.85 if AGEn 1.0.50.40.30.20.10123456789 10 11 12 13 14 15 16 17 18 19 20Age in YearsTractorCombinePlanter, TillageBalermachines, most notably for combines, rate of usemay be as important for determining market valueas is age (Cross and Perry; Kastens, Featherstone,and Biere). This is likely due to the number of usedcombines that have been originally owned by custom harvesters. Such machines are typically usedmore intensely and traded more often than farmerowned machines.Recently, economists have begun to deriveformulas that attempt to quantify the relationshipbetween rate of use and market value, especiallyfor tractors and combines, where hour meters havebeen standard for many years. However, for tillageand planting equipment, historical rate of use is difficult to quantify. For other classes, such as balers,it may come about because of bale counters. Crossand Perry examined auction sale prices reportedmonthly from January 1984 to June 1993 in theFarm Equipment Guide (Hot Line, Inc.). Equipmentmanufactured between 1971 and 1993 were considered. Their study resulted in the following formularelating market value to age and rate of use:Eq
1996) for a 1991 John Deere Model 9600 combine is to observe the list price at a John Deere dealer to-day (1996) for a 1996 John Deere Model 9600 com-bine.3 That value is the current list price for the 1991 used combine. However, the 1996 combin
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